Why it’s Important to Reinvest Dividends

Dividends, and reinvesting dividends, can often be an afterthought for investors. But should they be? You might find they can have a larger impact on growing your long-term wealth than you think. 

Whether you’re investing in a dividend-paying fund or are receiving dividends from individual companies directly, it’s important to have a plan around what you’re going to do when you receive them. 

At Kernel, all investors have the option to receive their dividends as cash or have them automatically reinvested. Before we jump into the nitty-gritty, here’s a quick overview of what dividend reinvesting is, and why it’s important.

A dividend is a form of profit on investments, paid out of the company’s earnings to shareholders. The company’s board of directors determine how much the dividend itself will be. To be eligible to receive dividends, you’ll need to own shares in the company before the ex-date (a date set by the company before the actual payment date).

In the instance of a fund, dividends from the underlying companies are paid to the fund manager (Kernel), who then pays a distribution to the individual investors.

Dividend reinvesting is simple, and the definition is in the name. It’s taking the dividends paid out by a company or fund and reinvesting it back into your investment portfolio. Some companies offer the choice to participate in a dividend reinvestment plan, otherwise known as a ‘DRIP’. A DRIP is an automated strategy in which a company or fund’s dividends are reinvested into additional shares of the company.

The simple answer is individual companies pay dividends, and investment funds pay distributions. When investing through Kernel, reinvestment means additional units purchased on your behalf in the fund. We pay distributions quarterly, so you’ll receive payment at the beginning of April, July, October, and just before Christmas (we bring our January payment forward slightly). Merry Christmas to that!

Each of our funds have varying yields, all of which are below:

1. It’s more money in the [investing] bank. By reinvesting your dividends you’re supplementing the amount you may have originally planned to invest. Which leads us to the next point…

2. You’ll get to your goals, faster. Naturally, the more money you invest, the faster you’re going to reach your investing goals. By choosing to reinvest your dividends versus cashing them out, you’re growing your wealth faster, and decreasing the time needed to hit your financial goals.

3. It’s easy (and free with Kernel!). Once set up, dividend reinvestments are out of sight, out of mind. So you’re growing your wealth, faster, without knowing it. When investing with Kernel, we take care of the admin, and at zero cost.

Let’s say Kernel Investor, Earnie, invested $1 into the S&P 500 index on 31st May 1963, 50 years later (after dividend reinvesting*), in 2013, he’d have $108.45. That’s an increase of over 8 times, and an average annual return of 9.83%.

In comparison, if Earnie hadn’t reinvested his dividends and cashed them out instead, he’d be left with $23.03 instead of $108.45. That’s 79% less than if he had reinvested the dividends.

Zooming out a little, the graph below illustrates the power of compounding when reinvesting (or not reinvesting) dividends. It shows a growth of $10,000 when invested in the S&P 500 from December 1960 up until December 2017, with the turquoise representing reinvested dividends, and the dark green showing your wealth had you chosen to receive dividends in cash instead.

*at 3.1%, the average dividend yield for the S&P 500 from 1963 – 2013.

As you can see, reinvesting your dividends instead of cashing them out can have more of a positive impact on building your long-term wealth than you might think. With minimal effort over the course of 50 years, you could’ve earned an extra $2,111,825 had you reinvested your dividends rather than cashing them out. This is truly where the true power of dividend reinvestment lies.