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Wednesday, August 28, 2019

Why Reinvesting Dividends is a Smart Investing Strategy

Becoming a Dividend Growth Investor is not a quick way to get rich. It requires you to have a strict discipline to hold those dividends paying stocks for a long term period. The longer the investment horizon you have, the better the result your portfolio will have in the future. Historically, the total return of the S&P 500 has delivered just over 9% per year. Half of the total return comes from price appreciation while the other half comes from dividends. This proves that dividends are driving force to S&P 500 total return performance. Readers that have been following my blog know the benefit of owning dividend stocks. As a Dividend Growth Investor, you will receive dividend payment that will be paid every quarter for the stocks you own. Whether you are looking for a source of income for now or building your portfolio for the future, owning dividends stocks can be beneficial towards your long term investing. With dividends coming in, you will have the choice to either use the dividends received for your expenses; put a down payment on your property, or you can just store the extra cash in your brokerage account. However, one crucial part of becoming a successful dividend growth investor is to use the dividends received from your portfolio to be reinvested in stocks that pay dividends. This might seem to have very little impact to your portfolio of having the dividends reinvested in the beginning, but over a long period of time, the power of compound interest can multiply your dividend growth portfolio at an exponential growth. Dividend reinvestment is one of the simplest ways to grow your portfolio. When you reinvest your dividends, you get a massive advantage compared to not reinvesting your dividends. Since my goal to financial freedom is still far ahead, I am currently not using the dividends I receive from my portfolio for my daily expenses. In fact, I personally am reinvesting the dividends I receive from my portfolio in order to have better financial result. When my dividend growth portfolio produces significant amount of passive income (dividends) in the future, then I will start using the dividend earnings for my early retirement. In this article, I will explain why reinvesting your dividends is a smart investing strategy for your portfolio.

What Does Reinvesting Dividend Mean?
There are many reasons to choose dividend investing over taking cash, and I’ll cover the reason here. With each dividend stock you own, you will receive a dividend payment that’s paid every quarter. You don’t have to invest the dividends to the same stocks you already invested in. Having dividends paid out to your brokerage account give you the option to buy other dividend growth paying stocks that might be in the value territory. However, if you feel like purchasing the same stock that’s paying the dividends, that’s totally fine as well. By having the dividend reinvested in dividend paying stock will result you to own more shares of the chosen stocks in your portfolio. It is the easiest and cheapest ways to increase your holdings over time. To illustrate this, let me give you an example scenario. Let’s say you own 1,000 shares of Altria Group Inc. (Ticker: MO) that you purchase at $50 per share. Let’s then assume that Altria Group Inc. pays an annual dividend of $5 per share which will result you to receive $5,000 in dividends (1,000 shares x $5 per share) in the first year. If you decide to use the dividends of $5,000 to be reinvested in Altria Group Inc. at the same purchase price of $50 (price usually fluctuate). This would result you to own 1,100 shares of Altria Group Inc. (Ticker: MO) in your portfolio. Towards the upcoming year, if Altria Group Inc. pays the same dividend of $5 per share. You would receive $5,500 in dividends (1,100 shares x $5 per share) a year after purchasing 100 shares of Altria Group Inc. with the dividends that’s paid out. This shows that having your dividends reinvested in the stock you are holding will increase the amount of shares as well as an increase of dividend payment to your portfolio. However, results could be much better if your stock increase is capital value as well increases its dividends every year.

Reinvesting Dividends Will Result Significant Difference Result in the Long Run.
Having dividends you receive to be reinvested in your dividend growth portfolio is a good approach to a long term investment strategy. By reinvesting your dividends, you can accelerate the power of long-term compounding in your investment account. With the power of compound interest, your dividend growth portfolio would result significantly better compared to not reinvesting your dividends. By plowing dividend income back into high quality dividend paying stocks, investors may meaningfully increase their annual returns and total assets. Recent studies shows that when you have a portfolio of $10,000 in the S&P 500 index fund from the year of 1960 to 2017 will give you significant different result when you have the portfolio reinvested compared to not having dividend reinvested. I have provided a picture graph comparing the result when you have dividend reinvested and when you don’t reinvest the dividend. When you don’t reinvest the dividends, your $10,000 S&P 500 index fund portfolio would result you to have $460,095 in the year of 2017. This is a huge gain to your portfolio value, having your portfolio to multiply close to 46 times (4600%). However, when you have the dividend received reinvested regularly, your $10,000 S&P 500 index fund portfolio would result you to have $2,571,920 in the year of 2017. That’s a difference of $2,111,825 in the ending balance if you have the portfolio’s dividend reinvested. When you have the portfolio to have dividend reinvested will result you to multiply your ending balance close to 257 times (25,700%) from its original starting balance in the year of 1960. From this research, this proves that reinvesting dividends is a strategic investment move if you are planning to hold your portfolio long term. It will give you an enormously different final result when you decide to reinvest your dividends since the extra cash (dividends received) being reinvested can mean huge difference over a decade or more of compounding.

Reinvesting Dividends Can Turn a Slow Growth Company Into a Better Investment.
There is a research proves that reinvesting dividends to your slow growth company could result you to have a better investment performance. In the book “The Future for Investors” by Jeremy J. Siegel showed an interesting statistic by one of the professor. The book stated that between 1950 and 2003, IBM (Ticker: IBM) grew its revenue by 12.19% per share, dividends at 9.19% per share, earnings per share of 10.94% and sector growth of 14.65%. At the same time, Standard Oil of New Jersey which is currently part of Exxon Mobile now had revenue per share growth of only 8.04%, dividend per share growth of 7.11%, earnings per share growth of 7.4%, and sector growth that is negative 14.22%. Comparing these facts, which company would you prefer to invest in 1950? The answer may surprise you. If you have invested $1,000 in IBM in 1950, your $1,000 would only grow to $916,000 while the same amount invested in Standard Oil would result you to have $1,260,000 which is approximately $300,000 more even when the oil company’s stock only increased by 120 times during this period, and IBM stocks had increased by 300 times. The performance difference comes from those insignificant dividends that people underestimate. Despite the much better per share price appreciation of IBM stocks, the investor who bought Standard Oil and reinvested their cash dividends would have accumulated over 15 times the number of shares they started with while the IBM investor would only acquire 3 times their original amount. This demonstrates that even when a company have better operating performance, the price you purchase the stock is equally important as well.

Reinvesting Dividend is Great Investment Opportunity During Market Turmoil.
The benefit of owning a dividend growth portfolio is that you are still able to receive dividend even when the market is going down. I like the fact that the dividend receive is like having real excess money coming in your pocket. With the available cash coming in to you, you are able to use the opportunistic bear market to purchase more shares in high quality dividend growth stocks. As Warren Buffett advice “you should be fearful when others are greedy and be greedy when others are fearful.” What he meant by this is that you should be careful when stock market has gone up too much (Bull Market) since companies might be overvalued, and to instead take the opportunity to purchase stocks when there is a down market (Bear Market). During bad market, there are many great stocks with strong fundamentals that are trading at a discount. You want to use this opportunistic time to accumulate more dividend growth stocks with the dividends that are paid out to you. You will benefit from the high starting dividend yield the stock pay out. I’m not worried about upcoming market crash, since I’m prepared to invest more of my money during this opportunistic time. A Bear Market can be a buying opportunity for investor to invest in dividend growth stocks. I personally love when the stock market is going down. This enables me to purchase my favorite dividend stocks at a much cheaper price. When the stock price is low, I’m able to accumulate more stock shares in my portfolio that have a great dividend starting yield. However, I will still need to cautious with the fundamental of the company before investing. You don’t want to invest in the stocks that are value trap which can cost you to lose your investment principle.

The Bottom Line
As part towards my journey to financial freedom by investing in dividend growth stocks, reinvesting the dividends received is crucial strategy to boost my portfolio returns over the long run. By simply reinvesting your dividends to your portfolio is a great investment strategy to build passive income stream and wealth. Having my dividends reinvested to dividend paying stocks enable my portfolio to perform a significant higher result compared to not reinvesting my dividends that I receive. There are many studies that show the enormous different result when you have dividend reinvested comparing to not reinvest the dividends. If your journey to financial freedom is still far ahead, it’s beneficial to have the dividends received to be reinvested in dividend paying stocks in your portfolio. I know this can be difficult since you had to forgo the use of the income along the journey, losing time and experience you can use for clothes, vacations, or other purchases. However the benefit of reinvesting the dividends is too great to be ignored. You are able to compound your portfolio at a higher return rate, giving better financial result when you are ready to actually use the passive income your portfolio is going to provide. So be patient and don’t get tempted to spend the dividends you receive especially if you are still young. Learn that by being consistent with your investment approach and to be patient can make you wealthy in the long run. I personally am not using the dividends I receive from my portfolio for my expenses; instead I am currently reinvesting the dividends to dividend paying stocks that are in the value territory. By doing this, I hope my passive income in the future will be significantly higher, giving me the opportunity to enjoy the fruits that I have planted now. My goal is to have a dividend growth portfolio that can pay me up to $200,000 in dividends each year (After Tax). I think to have a portfolio that pays me that much in dividends allows me to have a comfortable and joyful life. I really want to get out of the rat race that prevents me to have the freedom I always wanted. I want to have the ability to not worry about money in the future. However, to reach that financial goal require me to be discipline with me reinvesting my dividends, and to always take the opportunity of market turmoil to invest in quality dividend stocks. Withdrawing dividends is something I want to do at the end of my financial journey. I hope this article I wrote can inspire you readers to do the same of reinvesting the dividends to your portfolio. Remember! Your patience now will be rewarded later.

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