Today I will discuss the importance of reinvesting your dividends in the great company that you identified and now own. A dividend is a quarterly or annually distribution of a portion of a company's earnings(Investopedia). Often times, investors are paid a quarterly cash dividend, and don't think about it as much more than that. However, a wise investor would look to set up a Dividend Reinvestment Plan (DRIP). In this "plan," the shareholder requests that his quarterly dividend be paid directly in stock rather than cash. This eliminates an additional transaction in which you have to contact your broker with the same order each time you receive a dividend payout. As you will see in a minute, by increasing your number of shares every three months, you significantly increase your returns. Let's look at two different investors: Steve and Carl. Steve and Carl both make a $10,000 investment in McDonald's(MCD). For our sake let's assume that McDonald's costs $100 per share (actually 98.42). Both investors want to hold their 100 shares for 30 years without selling, or spending any additional money to increase their holding size. However, Steve wants to reinvest his dividends, while Carl wants to use his dividends to go out to a special restaurant every 3 months. Unfortunately Carl does not realize that he is severely restricting the amount that his investment can appreciate. If McDonald's stock price does not increase in the next 30 years, Carl will be left with a $9,390* profit simply from dividends...not bad (nearly a 100% gain). Steve will make far more money than Carl since he wisely reinvested his dividends. Here is how Steve accomplished such a feat...First Steve had 100 shares, but each quarter he had a few more shares since he used his dividends to buy more shares of McDonald's. Then Steve had more shares that paid him a dividend, so he had even more money the next quarter, to buy more shares! This snowballed in an account value worth $25,000! Nearly $6,000 more than Carl's $19,930*. Now imagine they had made these investments when they were teenagers and were actually planning to hold for 60 years! Carl again would be left with his $10,000 initial investment plus $19,860 (dividends). Here is where Steve's wise investment pays off...Steve's account will be worth $63,500! More than double Carl's account value. REMEMBER! Steve accomplished this with McDonald's stock price never increasing over 60 years! Amazing! The reason that Steve was able to do this was because after 60 years he had accumulated 635 shares of McDonald's stock while Carl still had his 100 shares.
*Price is kept constant at $100 over 60 years.
*Dividend remains $3.13 per year or $.7825 per quarter
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Carl
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Steve
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Initial Investment
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$10,000
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$10,000
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Number of Shares (Year 1)
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100
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100
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Account Value (30 Years)
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$19,930
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~$25,000
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Account Value (60 Years)
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$29,860
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~$63,500
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Number of Shares (Year 60)
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100
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635
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Use this link, and see how important dividends are to you!
http://loanlane.com/divcalculator2.php
MAKE SURE YOU SCROLL DOWN AFTER PRESSING "CALCULATE"
*$9,390 = ($3.13 Dividend per Share) x (100 shares) x (30 years)
*$19,930 = $9,930 (from dividends) + (10,000 initial investment)
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