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AAM Viewpoints – Cash or Reinvest? The Million-Dollar Question


Most investors are aware of the positive impact dividends can have on equity performance. According to S&P Dow Jones Indices, more than a third of long-term total return from equities can be attributed to dividends. Specifically, from December 1926 to December 2018, dividend income constituted 33% of the monthly total return of the S&P 500, with the remaining portion coming from capital appreciation.S&P Dow Jones goes on to illustrate the effect of compounding and summarizes another important aspect of dividends; as the time horizon lengthens, the compounding effect increases exponentially. The effect can be so powerful that Albert Einstein famously dubbed compounding interest the “eighth wonder of the world.”

While there is plenty of research available that illustrates the positive impact of dividends, we have found few examples that demonstrate, in dollar terms, the three drivers of total return a dividend investor would likely experience over an average time-horizon. These drivers include current dividend yield, growth of the dividend stream, and capital appreciation. Such scenario analysis can be insightful on many levels. For example, one basic question every investor is faced with is: should dividend payments be taken as cash or reinvested into the portfolio?

The table below uses several market assumptions to model a possible difference in portfolio value based on dividend payments taken as cash versus reinvested. The assumptions used reflect what a dividend investor may have experienced over the last 25 years based on long-term averages (1993-2018).

Assumptions:

 

Initial Investment

$1,000,000

Initial Stock Price

$20

Initial Shares

50,000

Annual Capital Appreciation

6%

Constant Yield (reinvested annually)

3%

Dividend Growth

6%

Source: AAM

Year

Dividend Growth

Dividend Per Share

Yield

Share Price

Cumulative Shares

Dividend Income (DPS*Cum Shares)

Shares Bought via DRIP (Div Income/Share Price)

Value with Divs Reinvested

Value with No Reinvestment

Cumulative Dividends

Value with Cash Divs

Difference

0

0

$ 0.60

3%

$ 20.00

0

-

50000

$ 1,000,000

$ 1,000,000

$ -

$ 1,000,000

$ -

1

6%

$ 0.64

3%

$ 21.20

50000

$ 31,800

1500

$ 1,091,800

$ 1,060,000

$ 31,800

$ 1,091,800

$ -

2

6%

$ 0.67

3%

$ 22.47

51500

$ 34,719

1545

$ 1,192,027

$ 1,123,600

$ 65,508

$ 1,189,108

$ 2,919

3

6%

$ 0.71

3%

$ 23.82

53045

$ 37,906

1591

$ 1,301,455

$ 1,191,016

$ 101,238

$ 1,292,254

$ 9,201

4

6%

$ 0.76

3%

$ 25.25

54636

$ 41,386

1639

$ 1,420,929

$ 1,262,477

$ 139,113

$ 1,401,590

$ 19,339

5

6%

$ 0.80

3%

$ 26.76

56275

$ 45,186

1688

$ 1,551,370

$ 1,338,226

$ 179,260

$ 1,517,485

$ 33,885

6

6%

$ 0.85

3%

$ 28.37

57964

$ 49,334

1739

$ 1,693,786

$ 1,418,519

$ 221,815

$ 1,640,334

$ 53,452

7

6%

$ 0.90

3%

$ 30.07

59703

$ 53,862

1791

$ 1,849,276

$ 1,503,630

$ 266,924

$ 1,770,554

$ 78,721

8

6%

$ 0.96

3%

$ 31.88

61494

$ 58,807

1845

$ 2,019,039

$ 1,593,848

$ 314,739

$ 1,908,588

$ 110,452

9

6%

$ 1.01

3%

$ 33.79

63339

$ 64,205

1900

$ 2,204,387

$ 1,689,479

$ 365,424

$ 2,054,903

$ 149,484

10

6%

$ 1.07

3%

$ 35.82

65239

$ 70,100

1957

$ 2,406,750

$ 1,790,848

$ 419,149

$ 2,209,997

$ 196,753

11

6%

$ 1.14

3%

$ 37.97

67196

$ 76,535

2016

$ 2,627,689

$ 1,898,299

$ 476,098

$ 2,374,397

$ 253,292

12

6%

$ 1.21

3%

$ 40.24

69212

$ 83,561

2076

$ 2,868,911

$ 2,012,196

$ 536,464

$ 2,548,661

$ 320,250

13

6%

$ 1.28

3%

$ 42.66

71288

$ 91,231

2139

$ 3,132,277

$ 2,132,928

$ 600,452

$ 2,733,380

$ 398,897

14

6%

$ 1.36

3%

$ 45.22

73427

$ 99,606

2203

$ 3,419,820

$ 2,260,904

$ 668,279

$ 2,929,183

$ 490,637

15

6%

$ 1.44

3%

$ 47.93

75629

$ 108,750

2269

$ 3,733,760

$ 2,396,558

$ 740,176

$ 3,136,734

$ 597,026

16

6%

$ 1.52

3%

$ 50.81

77898

$ 118,734

2337

$ 4,076,519

$ 2,540,352

$ 816,386

$ 3,356,738

$ 719,781

17

6%

$ 1.62

3%

$ 53.86

80235

$ 129,633

2407

$ 4,450,743

$ 2,692,773

$ 897,170

$ 3,589,942

$ 860,801

18

6%

$ 1.71

3%

$ 57.09

82642

$ 141,534

2479

$ 4,859,321

$ 2,854,339

$ 982,800

$ 3,837,139

$ 1,022,182

19

6%

$ 1.82

3%

$ 60.51

85122

$ 154,526

2554

$ 5,305,407

$ 3,025,600

$ 1,073,568

$ 4,099,167

$ 1,206,240

20

6%

$ 1.92

3%

$ 64.14

87675

$ 168,712

2630

$ 5,792,443

$ 3,207,135

$ 1,169,782

$ 4,376,917

$ 1,415,526

21

6%

$ 2.04

3%

$ 67.99

90306

$ 184,200

2709

$ 6,324,190

$ 3,399,564

$ 1,271,769

$ 4,671,332

$ 1,652,857

22

6%

$ 2.16

3%

$ 72.07

93015

$ 201,109

2790

$ 6,904,750

$ 3,603,537

$ 1,379,875

$ 4,983,412

$ 1,921,338

23

6%

$ 2.29

3%

$ 76.39

95805

$ 219,571

2874

$ 7,538,606

$ 3,819,750

$ 1,494,467

$ 5,314,217

$ 2,224,389

24

6%

$ 2.43

3%

$ 80.98

98679

$ 239,728

2960

$ 8,230,650

$ 4,048,935

$ 1,615,935

$ 5,664,870

$ 2,565,780

25

6%

$ 2.58

3%

$ 85.84

101640

$ 261,735

3049

$ 8,986,224

$ 4,291,871

$ 1,744,691

$ 6,036,562

$ 2,949,662

Source: AAM | For illustrative purposes only. Past performance no guarantee of future results.

cash or reinvest?Source: AAM

As you can see the benefits of dividend reinvestment are exponential. In our example the difference in portfolio value is relatively modest in years 1-10 (less than $200,000), but balloons into the millions as the time horizon increases. Beyond that it is typically cheap, easy to set up, and an excellent way to dollar-cost average. Despite the obvious benefits, every investor is unique and may not have the luxury to reinvest. Perhaps there are others who are unaware of just how big the difference can be. This is a fundamental conversation every financial advisor has the opportunity to address with their clients.

According to life expectancy data from the U.S. Census Bureau (84 years for men, 86.5 years for women) and the full retirement age of 67 set by the Social Security Administration, we can deduce the average full retirement length to be approximately 18 years. One last look at the table above shows the difference in the “cash” portfolio versus the “reinvest” portfolio at the end of year 18 conveniently hits $1,022,182, making the cash or reinvest decision for someone entering retirement truly a million-dollar question.

1 Soe, Aye, “Dividend Investing and a Look Inside the S&P Dow Jones Dividend Indices,” September 2013, S&P Dow Jones Indices.

CRN: 2019-1004-7727R

Hypothetical income figures are not indicative of future results; actual income may be lower or higher than the annual dividend income shown.


This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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