Rewards of reinvesting dividends
What a difference dividends make. A company’s dividends, based on the value of its stock, can be a good indicator of the company’s strength and prospects. Paying dividends shows it’s doing well enough to distribute some of its income to shareholders. When a mutual fund’s holdings pay dividends, the fund passes them on to shareholders. Investors can take a fund’s dividends in cash, or they can reinvest and use them to buy more shares, which can help an account value accumulate faster. While past results do not guarantee results in future periods, it’s worth noting that since 1929, dividends have accounted for nearly half of the S&P 500’s total return.
When reinvested, the power of dividends is multiplied. A hypothetical investment of $1,000 in the S&P 500 on December 31, 1993, would be worth $3,070 twenty years later if all dividends were taken in cash. However, if the dividends were reinvested, that same $1,000 would be worth $5,830 – nearly twice as much.
The gap can be dramatic in a low-return environment when share prices are growing slowly or not moving at all. Dividends could be the only positive return an investor receives in a flat market. In a recent 10-year period (8/7/2001 – 8/7/2011), for instance, the S&P dropped 0.04%. Investors who started with a hypothetical investment of $10,000 in the S&P and took dividends in cash would have ended up with an account value of $9,958. However, those who reinvested dividends during that period would have seen a positive return of 1.90%, and their $10,000 would have grown to $12,076.
Reinvested dividends can help add to total return because they allow you to purchase additional shares, which could appreciate and provide additional dividend income. They can increase returns when the market’s going up, and could add a bit of a cushion during downturns.