Don't Spend Your Dividends

By in Advanced Investing, Bond, Investing, Stocks | 19 comments

REINVEST YOUR DIVIDENDS

What Are Dividends and Payout Ratios?

With interest rates at historic lows and increasing volatility in major stock indexes, dividends have become the rallying call for investors. Blogs devoted to dividends proliferate and investors believe that dividend stocks are the best equity investment. Don’t get me wrong, dividends are fine, but just because a stock pays a hefty dividend does not mean it is a great investment. And the dividends the stock throws off are not “free money”.

What is a Dividend?

Dividends are earnings a company is electing to pay to the shareholder in lieu of reinvesting in the company. If the company does not pay a dividend, the earnings are used within the company to fuel growth initiatives, which if successful, will lead to higher share prices. If a company pays out a portion of those earnings, they are communicating that they believe you have a better use for those funds than the company does.

Wait a minute. Dividend paying companies are out of growth ideas?

Not exactly, usually dividend paying companies are older more established firms with a decent track record. These companies are confident that they will continue to grow into the future and decide to allow shareholders to participate in their profits now instead of waiting until the shareholder sells their stock to benefit.

What Is a Dividend Payout Percent?

Dividend payout percentages or the percent of net income that is paid out as a dividend varies. Back in the dot com boom of late last century, investors didn’t care about dividends nor did they flock to high dividend companies. The reason was because of a (mistaken) belief that the economy was transformed and beginning a new era.

In 1999, the S & P 500′s dividend yield was at a low point of 1.14 percent. Investors believed that with the advent of greater technology, stocks would grow and share prices appreciate faster than in the past. Thus, investors wrongly thought, “Who needs a dividend if the stock price is appreciating 15 to 20 percent per year?”

dividend payout ratios

Historical Dividend Payout Ratios

After the bursting of the technology bubble in the early years of this century, investor’s clamored for dividends. During the 2000-2002 bear market, when stocks fell 47 percent, the payout ratio reversed.

Today, investors love dividends, and companies comply by offering larger proportion of their net income back to investors. According to Ron DeLegge of ETF Guide, dividend payout ratios are at 31.8 percent, the highest level in 15 years.

Whether a company pays a dividend or not does not make that firm more or less profitable. The sales and growth of that company, along with wise use of its resources is what creates shareholder value. A dividend is not “free” money. A dividend is part of the profits of the company. If you spend your dividends instead of reinvesting them, you are giving up a grand opportunity to multiply your wealth.

Why You Shouldn’t Spend Your Dividends?

Let me preface this statement by saying, if you are in the retirement phase of your life and living off of your investments, there is absolutely nothing wrong with spending your dividends. This message is directed at those in the accumulation phase of their lives and building their net worth.

Dividend Reinvestment Case Study

Marlon holds shares in Awesome Industries. He bought 100 shares at $10.00 per share, for a total outlay of $1,000.00. Awesome pays a 1.5% dividend. Annually, Marlon receives $15.00 from his investment in Awesome.

If Marlon spends that $15.00 per year, that’s it, the money is gone!

If Marlon is a savvy guy and decides to reinvest his dividends and use them to purchase more shares he’ll have a lot more cash at the end of 10 years. Assume that both the company and its dividends grow at 7% per year.

After 10 years, at 7% annual growth, if Marlon spends his dividends, his stock is worth $1,967.00.

But Marlon decides to reinvest his dividends each year in more shares of Awesome.

At the end of 10 years, Marlon’s initial $1,000.00 investment is worth $2,282.60. For an annual compound rate of growth of 8.6%.

By reinvesting his dividends, he earned an additional $315.60 or 1.6% annual  return.

The Takeaway

Reinvest your dividends and your money will make more money. Spend your dividends and the money is lost. Reinvesting dividends over the long term is one of the best ways to build substantial wealth.

For those with dividend income, do you spend or reinvest?

A version of this article was previously published.

    19 Comments

  1. Great advice! It’s likely you won’t miss those dividends anyway when they are automatically reinvested.

    Maggie@SquarePennies

    February 1, 2012

  2. I totally agree! I reinvest dividends and capital gains. Fo me these are investments that I want to grow until I need them.

    krantcents

    February 1, 2012

  3. @Maggie and Krantcents-It’s amazing to reinvest and find out years later how much the holding has grown.

    Barb

    February 1, 2012

  4. Dividends shouldn’t be spent until we’re in retirement. And probably, not even then.

    101 Centavos

    February 1, 2012

  5. When it comes to stocks, I have always reinvested dividends. It seems like the default option, and hopefully most people take this approach. Let compounding help you retire :)

    Squirrelers

    February 2, 2012

  6. We definitely reinvest our dividends. It’s very exciting when we get paid our dividends (only once a year), because it feels like free money!

    Amanda L Grossman

    February 2, 2012

  7. To all! I have nothing to say, you all are way too smart, reinvesting your dividends and I assume capital gains as well. You’re on your way to wealth!

    Barb

    February 3, 2012

  8. I have all my funds setup to reinvest both capital gains and dividends. When I retire I may look at reallocating a portion of my portfolio and take the dividends as a distribution.

    Paul @ The Frugal Toad

    February 10, 2014

  9. I take dividends in cash, but I don’t spend them. I reinvest them, but rather than back in the source of the dividend, into whatever I find appealing at the time.

    Kurt @ Money Counselor

    February 10, 2014

  10. @Paul, You’re good to go. Now sit back and enjoy life!
    @Kurt,Interesting plan. I think that’s a unique take on the “dividend reinvestment”. Would you like to write an article about that here?

    Barbara Friedberg

    February 10, 2014

  11. I treat dividends in a similar fashion as Kurt @ Money Counselor. I take dividends in cash, and then reinvest in the asset class that is under weighted for my desired asset allocation. I do the same with new money that we add to our investment accounts every month.

    Bryce @ Save and Conquer

    February 11, 2014

  12. Cool advice! However, the bulk of my investment profits don’t really come from dividends – I focus more on capital gains. A 5% dividend is easily shadowed by a simple swing in a stock price.

    Troy

    February 12, 2014

  13. It’s all about re-investing those dividends!! Much of your return is made up of all of those dividends so not re-investing them only makes sense for those living off of their investments for income.

    Jon @ Money Smart Guides

    February 12, 2014

    • @Jon, It is absolutely remarkable how one’s money can grow over the years by reinvesting the dividends. The trick is not to look at your investments too frequently as values do bounce around a bit.

      Barbara Friedberg

      February 14, 2014

  14. Hi Troy, You make an important point. Whether you get your investment growth through dividends or capital gains is really irrelevant. One can just as easily sell shares to obtain cash flow from an investment as they can by receiving a dividend.
    @Jon, Thanks for reiterating this important point. Over time, with reinvestment, a small initial outlay can grow into a large sum of money.

    Barbara Friedberg

    February 12, 2014

  15. I always reinvest my dividend income. I don’t even really see it as income, because it’s always been out of bounds for spending. Why not make more money!

    Tushar @ Everything Finance

    February 15, 2014

  16. @Tushar, That is exactly my viewpoint. When people (who aren’t retired) count their dividend income along with their earned income, I’m surprised. Reinvesting, over decades leads to true passive long term wealth.

    Barbara Friedberg

    February 17, 2014

Post a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

WP-SpamFree by Pole Position Marketing