One of the most powerful forces behind building wealth in the stock market comes from the compounding effects of reinvested dividends. As investors, it’s great to be able to know what to expect from those returns when planning for the future.
In this post, contributor Andy Shuler introduces a simple dividend reinvestment calculator to roughly estimate how much return to expect from a given dividend reinvestment rate and starting yield, so that you can make these determinations for yourself and your financial planning.
If you have ever listened to any of the Investing for Beginners podcast episodes, then you likely have heard from Andrew or Dave about the value of dividend reinvestment and DRIP. I mean, Andrew is the (self-proclaimed) DRIP King lol. DRIP, or Dividend Reinvestment Plan, is really a pretty simple concept.
In essence, when you receive a dividend payment from owning a stock, you can either receive that as a cash payment or you can have it DRIP into your current position.
Let me help explain this with an example.
Imagine that you own 50 shares of a company that’s currently priced at $100/share. If that company pays a $1 dividend, then you could either get a $50 check or you could DRIP it into your current position. So, in essence, that $50 dividend payment would net you another ½ share of the company ($50 payment/$100 share price = ½ share). So, now your total position for this stock would be 50.5 shares. See below:
At face value, yes, either way that you choose to receive your dividend payment, you are getting $50 of value. But when you DRIP your investments, there are a lot of unwritten values that you receive. For instance:
- When you DRIP your investments, you’re dollar-cost averaging future investments in the company every time that the dividend is paid, which is usually on a quarterly basis.
- You’re going to be making four purchases every year, once every quarter, that will help smooth out the fluctuation in the market price
- Compound Interest
- You’re putting your money into the market as quickly as possible which allows you the best chance to maximize your gains
- You have the ability to buy partial shares
- Brokerage firms typically allow you to buy partial shares, which is huge! In the above example, if you couldn’t buy a partial share, you’d have to wait until the next quarter to earn another $50 so you could then buy a share, assuming the price was still $100. Not only does this let you dollar-cost average less frequently, but it also makes you lose out on three months potential for compound interest.
- You avoid commissions from your brokerage firm
- This might be my favorite part, honestly…many brokerage firms allow you to purchase more shares of a stock for no fee at all, even if you’re purchasing whole shares. It almost feels like you’re pulling one over on your firm! But they give this benefit to you to entice you to put that money right back into the market.
- You save time as the DRIP is completely automated on your end
- When you receive the dividend, it’s going to automatically DRIP back into your position. Nothing is needed to be done on your end.
Imagine the following scenario…
- You invest $2000 in a stock
- You assume that the stock will grow 8% annually
- The stock is currently earning a 2% annual dividend (this is about what the S&P 500 earns currently)
- You assume that the dividend yield will increase 3% annually
Now let’s use this to compare the value of DRIP vs. Non-DRIP. If you were to just take the dividend and sit on the cash for 50 years, you would end up with $86,854.84 in equity and $72,815.75 in dividend payments.
But, if you were to DRIP your investments, you would have $0 in cash because it was all reinvested, but you would have a total equity stake of $235,755.19, or an incremental value of $76,084.60 over the non-DRIP alternative!
That, my friends, is a huge stack of cash!
I know some of you are saying, “Andy, this doesn’t work, because I would invest that money in some other way rather than letting it sit there.” Yeah, I get that, Mrs. or Mr. Commenter, but you would also pay $5+ in commission each time you bought/sold, miss out on the full value of the compound interest because you would only be able to buy full shares, and you’d spend time doing this manually – none of which would occur if you were to DRIP.
I am a huge proponent of DRIP and I think that it truly is an amazing tool that you all should take advantage on your dividend stocks.
To setup your account is pretty easy, but it does vary from firm to firm. Chances are, you can probably type “dividend reinvestment plan” into the search bar and it will show you exactly how to do it. I use Fidelity, and it was very easy for me to setup. I can track my DRIP transactions when they happen, as you can see from an example below where my Visa dividend had gone through a dividend reinvestment:
I created another one of my simply calculators to help show the meaning of DRIP even more than I can verbalize, and to give you a tool to play around with to help give yourself a better idea of the full potential of DRIP. Again, this is a really simple dividend reinvestment calculator and you can poke holes in it if you want to, but this will help paint the picture with a broad stroke, so you can understand why you should DRIP your portfolio.
To use this dividend reinvestment calculator, you will need to input four pieces of information, such as the investment amount, your assumed dividend growth rate, the annual dividend yield and the assumed stock growth rate, shown below:
Once you enter these pieces of information, you will then get an annual look at how your position as performed.
As you can see, Year 1 has a Total Earned of $2040, due to your $2000 investment and you earned $40 in dividends (2%*$2000).
In Year 2, your Total Earned has increased $2,248.59. This is calculated by taking your Total Earned in Year 1 ($2040) and multiplying that by your assumed stock growth rate of 8%, which gives you $2203.20.
Then, you’re going to earn a dividend of 2.06% (2% starting dividend with a 3% assumed dividend growth rate) on your $2203.20, which is a total dividend of $45.39. When you add $2,203.20 + $45.39, you end up with $2,248.59 for your Total Earned.
Again, this is a very simple tool, and some of you will say that most dividends are paid quarterly so it’s not an apples to apples comparison – and I agree.
But, to be fair, all that would mean is that you’re getting your money back into the market faster and increasing the time that it will compound, so this truly is a conservative look at a DRIP and dividend reinvestment calculator.
Hopefully by now you can see that the power of the DRIP is one that you don’t want to miss out on, so don’t.
Personally, I prefer to try to find FUTURE Dividend Aristocrats! I think that there’s a lot of hype around the Dividend Aristocrats, so if you can make it a point to find companies before they reach that status, then you can set yourself up for some major gains both in share price and in the dividends that you will inevitably receive.
There’s many reasons why you should do it, and the proof is in the pudding as I have shown you. I encourage you to download it and maybe put your own stock picks in there and let me know your thoughts – I’m always willing to create things that help provide value and make us all better, smarter investors!