Now's The Time To Reinvest Dividends

Published in Investing Strategy on 17 September 2009

There are many attractive dividends to be had these days, but they're not just for investors seeking income.

Quite a few of us Motley Fool writers have been banging on about dividends for a while now, and there's good reason -- this year has seen some of the best quality dividends on offer for some time.

Traditionally, investing for dividends has been considered the realm of those wanting income from their investments -- invest for growth in your youth when you have surplus money, and then change your focus to invest for income as you get older. Well, that's what the sensible old wise people in the investment industry tell us.

But I think that old saw, while valid to some extent, should definitely not be taken as a law, and that we should take our profits wherever and however we can find them. There will be times when we want income, but dividends are scarce, and we need to look to share price growth and the actual selling of shares to pay for our daily needs.

Conversely, there are times when long-term investors, not looking to take any money out of their portfolios for decades to come, should search for dividends for their capital growth.

One of those times, I think, is now.

"But what am I going to do with the dividends I'm being paid in cash, when I don't want to take any money out of my long-term investments", you might ask. The simple answer is to reinvest it.

How do we reinvest?

One very good way to do that is to ask if your chosen companies will pay scrip dividends -- that is, instead of paying you cash, they'll convert it to the appropriate number of shares at the current rate, and you get those instead. A big advantage of scrip dividends is that you don't have to pay any stockbroker charges to get your new shares, but they are actually new shares, issued from the company's paid-up capital.

The second best option is a dividend reinvestment plan (a DRIP), which is set up by a company in order to pool dividends and buy existing shares on the open market. There will be dealing costs involved, but the company will be acting on behalf of many individual investors who have pooled their money, and will be able to get significantly cheaper terms than you would be able to get through your private online broker.

Finally, the last option, if neither of the above two are available, is to collect your dividend payments in your stockbroker account until you have sufficient cash to buy some new shares at a cost-effective price (which, with generally low dealing charges these days, can easily be as little as £250-£500). An advantage of this approach, just as when adding new money to your portfolio, is that you have the choice of buying more of the same (as with scrip dividends or DRIPs), or buying shares in a new company altogether.

Just do it!

But the important thing for long-term investors is that, whatever form they take, you should get your dividends reinvested. What difference does it actually make?

Let's go for an imaginary stock whose share price has been averaging a 6% growth per year and which regularly pays a 3% dividend, which is really not unrealistic for the some of the FTSE-100 stocks we're looking at today.

If you invest, say, £10,000, in that company's shares, and every year you take the dividends in cash to put towards holidays, beer, Big Brother telephone votes, or whatever fripperies take your fancy, after 10 years your initial ten grand will have grown to just under £18,000, which is really not bad.

But if, instead, you also reinvest your 3% dividend in shares in the same company, your stash will have grown to nearly £24,000 after 10 years -- you will be sitting on a profit of nearly 75% more than if you'd frittered away your dividends.

Total returns

So, the bottom line, really, is that it simply isn't true that share price appreciation is the only way to invest for capital growth for the long term, and that investing for dividends is reserved for people wanting to take regular cash out of their investments. In truth, whatever your current needs, you really need to base your strategy on whatever stocks are providing the best overall, total, growth in wealth.

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Csahowett 18 Sep 2009 , 5:41pm

A word of warning on scrips. I chose to take scrips on Standard Life and Aviva shares but I noticed the dividend was always invested too long after the due date and always at the top of the market. By receiving the dividends and saving them to a realistic value and timing my investment I reckon I have done better. I assume the reason for the high prices is the number of shares being bought at one time. By pestering the companies to find when they are actually buying one can identify a good time to sell!

cpfcse25 19 Sep 2009 , 10:04am

For once you haven't plugged one of your own services. The Motley Fool Sharedealing Service provides the option to have all dividends automatically reinvested at 1% commission (£10 max) + stamp duty, which is what attracted me to use it. There can be a couple of days delay before the new shares appear in your account but overall it is a good service and I have found it a better use of modest cash dividen amounts, particularly over the last year where depressed share prices have raised the percentage dividend yield significantly in a number of cases. If you want to take a particular dividend in cash, you just have to change your account settings at least a business day before the dividend is due to be paid and then revert to DRIP after it's paid.

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