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Financial Industry Insights from Advisors Asset Management
On October 22, 2019
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.1 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
Source: AAM
Year
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
$ 0.60
$ 20.00
-
50000
$ 1,000,000
$ -
1
$ 0.64
$ 21.20
$ 31,800
1500
$ 1,091,800
$ 1,060,000
2
$ 0.67
$ 22.47
51500
$ 34,719
1545
$ 1,192,027
$ 1,123,600
$ 65,508
$ 1,189,108
$ 2,919
3
$ 0.71
$ 23.82
53045
$ 37,906
1591
$ 1,301,455
$ 1,191,016
$ 101,238
$ 1,292,254
$ 9,201
4
$ 0.76
$ 25.25
54636
$ 41,386
1639
$ 1,420,929
$ 1,262,477
$ 139,113
$ 1,401,590
$ 19,339
5
$ 0.80
$ 26.76
56275
$ 45,186
1688
$ 1,551,370
$ 1,338,226
$ 179,260
$ 1,517,485
$ 33,885
6
$ 0.85
$ 28.37
57964
$ 49,334
1739
$ 1,693,786
$ 1,418,519
$ 221,815
$ 1,640,334
$ 53,452
7
$ 0.90
$ 30.07
59703
$ 53,862
1791
$ 1,849,276
$ 1,503,630
$ 266,924
$ 1,770,554
$ 78,721
8
$ 0.96
$ 31.88
61494
$ 58,807
1845
$ 2,019,039
$ 1,593,848
$ 314,739
$ 1,908,588
$ 110,452
9
$ 1.01
$ 33.79
63339
$ 64,205
1900
$ 2,204,387
$ 1,689,479
$ 365,424
$ 2,054,903
$ 149,484
10
$ 1.07
$ 35.82
65239
$ 70,100
1957
$ 2,406,750
$ 1,790,848
$ 419,149
$ 2,209,997
$ 196,753
11
$ 1.14
$ 37.97
67196
$ 76,535
2016
$ 2,627,689
$ 1,898,299
$ 476,098
$ 2,374,397
$ 253,292
12
$ 1.21
$ 40.24
69212
$ 83,561
2076
$ 2,868,911
$ 2,012,196
$ 536,464
$ 2,548,661
$ 320,250
13
$ 1.28
$ 42.66
71288
$ 91,231
2139
$ 3,132,277
$ 2,132,928
$ 600,452
$ 2,733,380
$ 398,897
14
$ 1.36
$ 45.22
73427
$ 99,606
2203
$ 3,419,820
$ 2,260,904
$ 668,279
$ 2,929,183
$ 490,637
15
$ 1.44
$ 47.93
75629
$ 108,750
2269
$ 3,733,760
$ 2,396,558
$ 740,176
$ 3,136,734
$ 597,026
16
$ 1.52
$ 50.81
77898
$ 118,734
2337
$ 4,076,519
$ 2,540,352
$ 816,386
$ 3,356,738
$ 719,781
17
$ 1.62
$ 53.86
80235
$ 129,633
2407
$ 4,450,743
$ 2,692,773
$ 897,170
$ 3,589,942
$ 860,801
18
$ 1.71
$ 57.09
82642
$ 141,534
2479
$ 4,859,321
$ 2,854,339
$ 982,800
$ 3,837,139
$ 1,022,182
19
$ 1.82
$ 60.51
85122
$ 154,526
2554
$ 5,305,407
$ 3,025,600
$ 1,073,568
$ 4,099,167
$ 1,206,240
20
$ 1.92
$ 64.14
87675
$ 168,712
2630
$ 5,792,443
$ 3,207,135
$ 1,169,782
$ 4,376,917
$ 1,415,526
21
$ 2.04
$ 67.99
90306
$ 184,200
2709
$ 6,324,190
$ 3,399,564
$ 1,271,769
$ 4,671,332
$ 1,652,857
22
$ 2.16
$ 72.07
93015
$ 201,109
2790
$ 6,904,750
$ 3,603,537
$ 1,379,875
$ 4,983,412
$ 1,921,338
23
$ 2.29
$ 76.39
95805
$ 219,571
2874
$ 7,538,606
$ 3,819,750
$ 1,494,467
$ 5,314,217
$ 2,224,389
24
$ 2.43
$ 80.98
98679
$ 239,728
2960
$ 8,230,650
$ 4,048,935
$ 1,615,935
$ 5,664,870
$ 2,565,780
25
$ 2.58
$ 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.
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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