Is it worth reinvesting dividends?

There are a few reasons why you might choose a dividend strategy for your portfolio. Regardless of these reasons, there is an important decision to be made after each dividend payout: Pay out or reinvest?

The advantage of reinvesting your dividends is that you can grow your capital faster and ultimately receive more dividends. Because by acquiring more shares of the same company from the distribution, the entitlement to future dividends increases, which in turn allows the acquisition of even more shares and thus even more dividends, and so on. In short, reinvesting dividends allows investors to benefit from the compound interest effect. This is particularly advantageous for investors who have a long investment horizon and wish to maximize asset growth over this period. This effect can be illustrated very nicely with a small example:

If, at the beginning of 2013, one would have bought shares of Realty Income (WKN: 899744) at the beginning of 2013, there would have been a dividend yield of 4.18% on this investment. This would have increased by an average of 5.26% over the next ten years. Over the same period, the share price would have increased by 4.52% per year. If all dividends received were fully reinvested without any further payment, this would result in a terminal value of €2,359.

If all dividends received had been consumed over the period, there would be a significant difference in the final result. The final value of the investment amounts to "only" 1,553€.

As this example shows, dividends should be reinvested in any case, especially if the portfolio is in the build-up phase.

Note on the calculation example:

I have taken the figures for dividend yield and increase from DivvyDiary. The calculation (before taxes) is done with the Dividenden-Rechner (2.4) from Aktientraum. Also, as always, past performance is no guarantee of future performance.

How do I actually reinvest my dividends?

In the USA, many companies offer a so-called DRIP program (Dividend Reinvestment Plan), where you receive new shares at the same value instead of a cash amount. In most cases, German brokers do not support this and if they do, it involves fees that are disproportionate to the dividends received.

In my portfolio I have the possibility to participate in such a DRIP program with Unilever and Diageo. At Trade Republic, this falls under specific client instruction and is associated with a cost of €5. This instruction must be requested individually for each distribution.

Since this is too expensive for me, I handle the reinvestment through my savings plans. To do this, I increase the existing savings plans by the amount distributed. In my opinion, this is the simplest and, above all, the cheapest way.

When does it make sense not to reinvest dividends?

In my opinion, there are three main scenarios in which reinvestment does not make sense:

The first reason is probably the most obvious one. With the onset of retirement age and thus usually the loss of income from employment, the additional income is needed. This is especially the case if the payments and income from other sources (e.g. statutory or company pension, insurance, rental income, etc.) are not sufficient to cover the cost of living or to increase it for a more comfortable standard of living through dividends.When reinvesting dividends, the effects on the portfolio weighting should also be considered. This can shift as a result of regular reinvestment. Positions with a higher dividend yield logically build up faster than those with a lower yield, which can result in an overweight. If the overweighted positions perform well, that is an advantage. If they perform worse, the losses are all the greater and overall performance can suffer significantly. In my opinion, this should be avoidable by regular review of the individual investment cases, according to the motto Buy & Hold + Check.Furthermore, it is advisable to refrain from reinvesting if the overall portfolio is to be diversified. For example, the dividends can be used to build up a new position or even to invest in new asset classes that allow reinvestment at a better rate of return.

Basically, one can say to the question raised at the beginning: It depends. Both alternatives offer advantages and disadvantages, so the decision whether dividends should be reinvested or not is a personal one that depends on the respective financial and investment opportunities and goals. If you have a long-term investment horizon, it makes absolute sense to reinvest your dividends in order to take maximum advantage of the compound interest effect. So especially if one is in the build-up phase of the depot and at the same time sufficient financial means are available that one does not need the dividend income. However, if regular income is required or other investment options appear more attractive, reinvesting the dividends received is not an option.

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