Survey says, “Maybe?” There are many variables to each person’s situation that you can’t just say reinvesting is best. But I’ll be the first to say that reinvesting is a great way to build wealth. My personal situation is allowing me to reinvest dividends for at least the next 10 years.
When you’ve built a dividend stock portfolio, you’ve got a handful of choices to make with your cash dividends:
- Pool the cash from your dividends to buy other companies
- Reinvest your dividends back into the company that paid the dividend
- Combination of reinvest and pool your dividends to buy other companies
- Live off your dividends
When does it make sense to pool the cash from your dividends to buy other companies? I’d answer that question with more questions. Does your stock portfolio need more quality companies (i.e. Johnson & Johnson, Coca-Cola, or Exxon Mobil)? Do you need more companies in your portfolio (i.e. more diversification)? Is your portfolio generating enough income? Does your portfolio need more growth (i.e. better earnings growth)? Are some of your stocks in industries (i.e. tobacco, banks, technology) that are better served taking the money and running?
If “yes” to any of those questions, it’s probably a good idea to pool at least some of your dividends to buy more companies. How much you pool depends on how much time you have until retirement. It also depends on your goals, soundness of portfolio, and sectors you own. Only you can make that determination.
It’s Time For The “Wealth” Talk
We can’t talk about reinvesting dividends without mentioning the concept of the buy and hold approach to investing. Stocks normally pay quarterly dividends and recent studies have shown stocks are only held approximately 6-8 months by investors.
If this short-term holding period describes your approach, then you might want to consider reading another blog. I’ll never suggest a 6-8 month hold period (never ever). Plus, it doesn’t make sense (or help your total return) if you are reinvesting dividends for a short period to time.
Buy and hold, and buy again when prices dip. That’s my mantra and it especially holds true for quality dividend stocks. Quality stocks can go flat for years and years. Honestly, when you are in accumulation phase, there is nothing wrong with flat prices. It gives you a chance to build a position that you can hold for years. It also gives you reinvested dividends time to buy on dips.
Let’s take a quick look at Coca-Cola. If you bought at it’s 2013 peak and sold at it’s 2019 bottom, you would have seen a flat stock price. All you would collect during this timeframe was the dividend. But if you adhered to the buy-hold approach, you would have participated in the stocks eventual 25% increase (and possibly more).
This 6-year time frame is the perfect example of how reinvesting dividends helps you. You collect more shares while the stock is down or flat until the eventual move upward occurs. That’s how you build wealth in reinvesting dividends.
Wealth is built with quality companies over decades, not months or a few years. You must buy and hold quality to participate in the wealth building process.
With quality companies, the market will eventually recognize it’s strength and the multiple is expanded (sometimes way too much). All that time you were building a position and reinvesting dividends finally pays off and wealth is created. This is truly a time when patience is eventually rewarded.
Reinvesting Your Dividends
If you don’t need the dividend income today, your portfolio is diversified in quality companies or you are in the process of diversifying it, and you have time on your side, then you are in a good position to reinvest dividends.
In many cases, reinvesting your dividends in quality companies can add another 1% – 3%+ to your annual total returns. That small increase can make a big difference in your portfolio and future dividend income.
Let’s use Johnson & Johnson to demonstrate how a buy-hold approach with a quality company will increase wealth and future income. If you bought $10,000 of J&J and reinvested your dividends over a 24 year period (1995-today), you would have many benefits:
- 11.3% total annual return (versus 9.98%)
- 432 more shares acquired with reinvested dividends (562 at purchase and 994 today)
- $1,641 more dividend income annually with your increased share count
- $35,089 increased value ($136,510 versus $101,421)
All these good things happened to your original $10,000 purchase because you reinvested your dividends for 24 years. More income to cover retirement expenses, more wealth created, and it was easy to do. The only effort from you was to click a button to reinvest dividends with your brokerage firm.
We could give example after example of the benefits of reinvesting dividends with quality companies. Reinvesting dividends in 3M over the last 25 years would turn $10,000 into $121,000 (versus $85,000).
And reinvesting dividends in Chevron over the last 24 years would turn $10,000 into $110,000 (versus $73,000 without reinvested dividends). You get the point … it can really help build wealth over decades.
Summary
So should you reinvest your dividends back into the stock? Maybe is the right answer based on your own personal situation, goals, and portfolio. But as I’ve shown, doing so can really boost your wealth and retirement income.
It’s important to know which stocks to reinvest dividends because some work better than others. Banks, technology, and some others can be a little dicey when it comes to reinvesting. That’s because some sectors can be very volatile. That’s why using a combo approach can work wonders for many portfolios. Reinvests dividends in some companies and takes the cash in others.
Thanks for reading!
Mr. TLR