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The Power of Reinvested Dividends - It’s Amazing!
By JLP | May 19, 2008
Had you purchased $10,000 worth of Chevron stock on December 30, 1988 and left it alone, you would have had $75,295 at the end of 2007. That’s an annualized rate of return of 10.62%. Not too shabby.
That’s only part of the story.
Over the years, Chevron would have paid you $22,734 in dividends. Add that to your ending balance of $75,295 and you get a grand total of $98,029, a 12.09% annualized rate of return.
That’s STILL only part of the story.
Look at the table below to see what would have happened had you reinvested those dividends back into Chevron stock.
At the end of last year, the account would have been worth nearly $163,000 (as of today’s close, it would be worth over $180,000). That’s a 14.97% annualized rate of return! Where did the growth come from? Three parts:
1. Capital gains. As I stated in the first sentence of this post, Chevron’s stock has grown an average 10.62% per year over the last twenty years.
2. Dividend growth. Chevron’s dividend has grown 6.64% annually over the last twenty years.
3. Compound growth. Reinvesting dividends back into a stock that’s growing and increasing their dividend on a regular basis will really compound growth.
I’m not saying that you should run out and buy Chevron or any stock for that matter. What I am saying is that you shouldn’t underestimate the power of dividends. Fortunately, there are a couple of dividend-focused exchange-traded funds that offer a more diversified approach to dividend investing. Check out iShares Dow Jones Select Dividend Fund (DVY), SPDR S&P Dividend ETF (SDY), and Wisdom Tree. There may be other dividend-focused ETFs and mutual funds out there but these will give you a good place to start looking.
Topics: Investing |
May 19th, 2008 at 10:01 pm
And just think, if you’d have bought $10,000 of ENE back in 1988… You might have some ornate pieces of paper today. If you were lucky.
May 19th, 2008 at 10:14 pm
The problem (as I see it) with reinvested dividends is that it creates weird increments and frequent purchases. Say you need to sell that Chevron stock after 20 years to buy something (or pay for retirement home, etc). You have 81 different purchase prices and amounts. Its a real pain in the rear to report all this for your accountant and the IRS.
At least in this case you made an initial large purchase. But that, to me, is the problem with programs like sharebuilder. It’s a pain in the rear when you have to report all these little purchases. Personally I save my dividends and repurchase the stock maybe once a year or every 2 years when I think the price is a good value. Or perhaps I’ll purchase an entirely different stock/fund. This way there aren’t so many small purchases quarterly and it is far easier to report.
I know you say you’ll hold the investment forever and the small purchases won’t matter, but let’s face it - life happens. We have down payments, emergencies, college and other large expenses - that’s what we’re saving for anyway.
May 19th, 2008 at 10:36 pm
KC,
Yeah, that’s a good point. The easy way out would be to invest through an IRA or tax-sheltered account. If not, KEEP good records!
May 19th, 2008 at 10:48 pm
KC,
Given the records kept by online brokerages now and days, this is a rather moot point. I can look up purchase and sell history at the drop of a dime and have it neatly organized. Nothing to keep track of on your end.
May 19th, 2008 at 10:51 pm
Marketplace referenced a similar analysis of reinvestment and the DJIA:
http://www.publicradio.org/columns/marketplace/farrell/2008/04/the_djia_crossed_554428.html
May 19th, 2008 at 10:52 pm
Of course all those dividends are being taxed too. The numbers don’t account for the taxation of the dividends. Sure, if you could compound all those dividends taxfree, it would add up. The real numbers would be somewhat smaller than this example if you accounted for taxes.
Still dividends are good, if you can get them in a tax deferred account. In a taxable account, it’s probably better to steer clear of dividends for tax efficiency. There is no free lunch!
May 19th, 2008 at 10:54 pm
JC,
I have a one-track mind.
What got me started thinking about this topic was the Chevron stock that’s in my wife’s 401(k). Therefore, taxes weren’t on my mind.
May 19th, 2008 at 10:56 pm
Merton H. Miller, “Do Dividends Really Matter?,” The University of Chicago Graduate School of Business, Selected Paper #57. This paper validates the idea that whether or not any particular stock pays dividends is irrelevant to the investor (except that the dividend-paying stocks are less tax-efficient, which is generally an undesirable feature). Written by a Nobel Prize winner.
Google it. A worthwhile read.
May 20th, 2008 at 12:16 am
This analysis also fails to take into account the cost of reinvesting the dividends.
May 20th, 2008 at 12:17 am
To KC… When you sell, the last four purchases would have to be reported as short term, and the rest would be long term. If you can figure the basis of the short term shares and the long term shares, you don’t need to report them all separately. Just use “various” as the date. It would only take 2 lines on Schedule D to report all of the purchases.
May 20th, 2008 at 8:41 am
Given the records kept by online brokerages now and days, this is a rather moot point.
***
That’s not true. I bought shares online in 2001 through TD Waterhouse. They merged with Ameritrade. Now on the TD Ameritrade website, my history no longer goes back far enough to show at what price I bought those shares.
May 20th, 2008 at 9:17 am
Are there any publicly available charting tools that will show dividend yields along with price? I find it very frustrating when trying to compare mutual funds, when you can’t see the dividends. I had one mutual fund where the 10 year price level was almost 0%, but the 10 year dividend yield was over 12%. But the charts (google, yahoo finance etc) all showed that fund as a big loser.
May 20th, 2008 at 9:50 am
This is exactly how my Father was able to retire at 60, even with 5 kids. Actually, he wasn’t that savvy - he didn’t know what to do with the blue chips he inherited, so he just put them on reinvestment and let them sit for 30 years. Following his lead, I’m letting my Exxon sit as well.
May 20th, 2008 at 9:54 am
For record keeping, a simple spreadsheet or document table will do the job. Things do get complicated when splits/stock dividends/takeovers are involved. Then it helps to have Quicken or Money and download the information monthly.
If you are going to make a partial sale of a stock, you have different valuation methods to choose from, I believe. And once you choose a method, you must stick with it until that asset is completely sold. The IRS, http://www.irs.gov, has Publications 550, 551, & 552 that discuss these topics, as well as Topic 409
May 20th, 2008 at 12:41 pm
…not so amazing with taxes & inflation factored in — you end up with only about $32K (..not 75K).
There are MASSIVE differences between the taxed and non-taxed numbers after 20 or 30 years.
And inflation is now getting as bad as taxes.
The “power-of-compounding” also works on these negative factors, unfortunately.
May 20th, 2008 at 12:45 pm
Brad,
I’d be interested to know how you came up with those numbers.
May 20th, 2008 at 5:22 pm
First Trade Securities, an online broker, reinvests dividends for free. Also if you invest through a Direct Stock Purchase plan with the company you want to buy stock in, they will usually reinvest dividends for free.
May 20th, 2008 at 7:10 pm
Dave is right. Calculating base price is quite easy. You are interested in the total base price, not the details for each purchase.
1. Separate short-term purchases - this shouldn’t be that tough, as there are only few of them.
2. For long-term: get the number of long term shares, multiply by purchase price - this is what you got for long term sale. For the base price don’t bother with details, go by total amount of money you invested over the years plus commissions for the original purchase and for the sale. The total amount of money you invested would include a) your original purchase b) dividends you received over the years. If you kept your past tax returns or/and end-of-year brokerage statements, it wouldn’t be that difficult. Put “various” for the purchase dates.
I’ve had some experience with reporting sales of ESPP stock which is even more complicated.
“If you are going to make a partial sale of a stock, you have different valuation methods to choose from, I believe”
It is FIFO unless you specify in advance to your broker which shares you are selling and have a broker send you a written note with the sale statement confirming which shares are sold.
May 21st, 2008 at 12:34 am
It is not that hard to keep track of all you need is a simple spreadsheet or you can use a portfolio tracking system from AOL, Yahoo, Etc.
For those of s that do not have $10,000 on hand Direct Stock Purchase Plans are great. I found about DSPP a little over 2 years ago.
Some examples are:
Kellogs (K) minimum first time investment $50 out of that is a $10 one time set up fee the other $40 goes to stock. After that you can invest as little as $25 per purchase and the money goes 100% into stock, Kellogs pays all of the fees.
Exxon Mobil (XOM) minimum first time investment $250 Exxon pays the set up fee, and after that you can invest as little as $50 per investment and Exxon pays all of the fees.
Kellogs has had dividend increases the last 3 years while Exxon has had increases the last 10 years, and both companies have been paying Dividends 80 years or more.
I found this to be such a great thing that I have listed over 150 companies on my web site at http://www.aplussrc.com that offer direct purchase plans and the best thing is its FREE. I have also included links to the company home pages, prospectus, and enrollment forms.
I have been buying direct for the last 2 years and my per share cost is down to .34 a share verses the .86 a share I had when I was using a broker and I am doing it $50 at a time instead of $1000 at a time.
May 21st, 2008 at 1:04 am
“I’d be interested to know how you came up with those numbers.” JLP
_____
…I used the free online calculator at
http://www.bygpub.com/finance/TaxFixedAmtCalc.htm
Unlike most basic financial calculators, it permits both tax & inflation factors for future-value interest computations.
You can plug in your own tax/inflation rate numbers, or use their suggested nominal rates.
State and local taxes may apply as well as Federal, depending where one’s legal residence is.
May 21st, 2008 at 6:23 pm
From personal experience, dividend reinvestment can truly be a beautiful thing. My grandfather invested $1000 in a utilities company for me when I was five years old and set it up for dividend reinvestment. Twenty-five years later, that stock has helped me get through both undergrad and graduate degrees, put a down payment on a house, and go on my dream honeymoon to Belize. And it’s still going strong. As for the taxes, I don’t know how our accountant does it exactly (that’s why we have her), but she doesn’t seem to have any problems with it.