There are several reasons why you might choose a dividend strategy for your portfolio. Regardless of these reasons, an important decision must be made after each dividend distribution: Cash out or reinvest?
The advantage of reinvesting your dividends is that you can grow your capital faster and ultimately receive more dividends. This is because by acquiring more shares in the same company from the distribution, the entitlement to future dividends increases, which in turn makes it possible to acquire even more shares and therefore even more dividends, and so on. In short, reinvesting dividends is a great way to benefit from the compound interest effect. This is particularly advantageous for investors who have a long investment horizon and want to maximize asset growth over this. This effect can be illustrated very well with a small example:
If you had bought shares in Realty Income for €1,000 at the beginning of 2013 (WKN: 899744) there would have been a dividend yield of 4.18% on this investment at that time. 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 final value of €2,359.
If all dividends received had been consumed over the period, there is a significant difference in the final result. The final value of the investment is "only" €1,553.
As this example shows, dividends should always be reinvested, especially when the portfolio is in the build-up phase.
Note on the calculation example:
I have taken the figures for the dividend yield and increase from DivvyDiary. The calculation (before taxes) was done with the Dividenden-Rechner (2.4) from Aktientraum. 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 is associated with fees that are disproportionate to the dividend received.
In my portfolio, I have the opportunity to participate in such a DRIP program with Unilever and Diageo. At Trade Republic, this falls under specific client instructions and is associated with costs of €5. This instruction must be applied for individually for each distribution.
As this is too expensive for me, I handle the reinvestment via 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 your dividends?
In my opinion, there are three main scenarios in which reinvestment does not make sense:
The first reason is probably the most obvious. When you reach retirement age and thus generally also lose your income from employment, you will need the additional income. This is particularly 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 living expenses or are intended to increase this for a more comfortable standard of living through dividends.When reinvesting dividends, the effects on the portfolio weighting should also be taken into account. This can shift as a result of regular reinvestments. Positions with a higher dividend yield logically build up faster than those with a lower one, which can result in an overweighting. If the overweight positions perform well, this is an advantage. If they perform worse, the losses are all the greater and the overall performance can suffer significantly. In my opinion, this should be avoidable by regularly reviewing the individual investment cases, in line with the motto buy & hold + check.It is also advisable to refrain from reinvesting if the overall portfolio is to be diversified. For example, dividends can be used to build up a new position or even to invest in new asset classes that allow reinvestment at a better return.
Basically, the question raised at the beginning can be answered as follows: It depends. Both alternatives offer advantages and disadvantages, so the decision as to whether dividends should be reinvested or not is a personal one that depends on the respective financial and investment opportunities and objectives. With a long-term investment horizon, it makes absolute sense to reinvest your dividends in order to make maximum use of the compound interest effect. This is particularly the case if you are in the accumulation phase of your portfolio and at the same time have sufficient financial resources available that you do 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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