How reinvesting your dividends can pay off

For most investors receiving a dividend payment can be quite exciting; it’s an added bonus from the money you invested. But, instead of spending the money, could you be better off reinvesting it?

Dividends in 2021

Australian shareholders have been rewarded with a record $41 billion payload of dividends from the 2020-21 financial year.
Globally, there are estimates that company dividend payouts to investors this calendar year could also break the previous record levels set before the COVID-19 pandemic and reach close to $2 trillion. It’s a stark turnaround from this time last year when payouts to investors slumped as many companies chose to stockpile their cash rather than spend it.

Now, many companies are keen to reduce the amount of cash held on their balance sheet. As well as declaring higher share dividends, some companies have also announced “special dividends” to return excess cash to shareholders. If you have direct share exposures to Australian companies paying dividends, you can expect distributions to start flowing fairly soon as dividend payments from 2020-21 are made. Exchange traded funds (ETFs) and managed funds will also be receiving company dividend payments, which will then be aggregated and paid out as distributions to their unitholders.

Related articles: What are dividends?

Should you reinvest your dividends?

As always, there’s a decision to be made on whether you should keep those dividends or distributions and spend them, or whether it’s better to reinvest them back into the market. For many investors, especially people in the pension phase reliant on regular income streams, company dividends and fund distributions are an important element of cash flow to pay for everyday living costs.
Investors in the pre-retirement (accumulation) phase may not need additional cash income. It all comes down to one’s personal income needs.

Boosting your long-term returns

But there’s compelling evidence that reinvesting company distributions will produce significantly higher investment returns over the longer term. The table below provides good context around the advantages of reinvesting income distributions over time.

What $10,000 invested 30 years ago would look like today. 

Vanguard table
Source: Vanguard

The table shows the average annual return of six different asset types over a 30-year period from 1 July 1991 – Australian shares, United States shares, international shares, Australian bonds, listed property, and cash.

It also shows how much a starting investment of $10,000 back in mid-1991 would have been worth at the end of June this year.
The total return numbers assume all the income received from distributions paid along the way were reinvested back into the same asset. They don’t include any buying costs or taxes.

What’s very clear is that the average annual returns from higher-risk assets such as shares have been consistently stronger over the last 30 years than lower-risk assets such as fixed income and cash. Anyone who invested $10,000 across the whole Australian share market three decades ago would have achieved a total return per annum of 9.7%, assuming all distributions had been reinvested.

By 30 June 2021 their initial investment, combined with distributions, would have compounded to $160,498. Alternatively, a $10,000 investment into the U.S. share market in June 1991 would have grown to $217,642 by 30 June 2021 if all income received had been reinvested back into U.S. shares. That’s based on the 10.8% average annual return from the broad U.S. market over 30 years.

Investing $10,000 in cash over 30 years would have achieved a total return per annum of 4.6% and grown to $38,938. The moral here is that reinvesting distributions over time, regardless of the asset class, will achieve long-term compound growth. Taking distributions such as share dividends in cash will invariably erode the benefits of those compounding returns, especially over the longer term.

How to reinvest your distributions

Reinvesting company dividends or distributions from shares, ETFs or managed funds is relatively easy. In respect to company dividends, many listed companies offer dividend reinvestment plans (DRPs) that allow you to have the cash value of your distributions converted into additional shares. This conversion is generally done at the market price on the day the company pays out its dividend.

DRPs can usually be selected through the share registry company that’s used by the listed company to manage its customer records, including changes in share ownership and dividend payments. The advantages of selecting a DRP option are that there are no additional brokerage fees involved when shares are added to an existing shareholding, and the overall process is automatic.

Likewise, ETFs and managed funds usually provide reinvestment options either as an automatic or opt-in investment feature. Where automatic reinvestment plans are not available, you can readily redirect cash received from distributions straight back into your investments by purchasing additional shares or units.

Either way, choosing to reinvest your distributions is a proven strategy for building long-term wealth.

Compare Online Share Trading Accounts with Canstar

If you’re comparing online share trading companies, the comparison table below displays some of the companies available on Canstar’s database with links to providers’ websites. The information displayed is based on an average of six trades per month. Please note the table is sorted by Star Rating (highest to lowest), followed by provider name (alphabetical). Use Canstar’s Online Share Trading comparison selector to view a wider range of online share trading companies. Canstar may earn a fee for referrals.

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Tony KayeTony Kaye

Tony Kaye is Senior Personal Finance Writer at Vanguard. He was a former manager at Standard & Poor’s Ratings and has a regular column in the Australian’s Wealth section. Tony has also written for newspapers nationally; The Telegraph, The Herald-Sun, The Advertiser, The Courier-Mail, NT News, Canberra Times and more. He has a Bachelor of Arts and Journalism at Curtin University and Public Relations at RMIT University.

Follow him on LinkedIn.

This content was reviewed by Content Producer