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Dividends get plenty of acclaim, but for some reason, the reinvestment of those payouts garners less attention. That’s interesting when considering all those statistics about dividends accounting for a significant percentage of a portfolio’s returns over time assume that dividends were reinvested.
“For example, a hypothetical $100,000 investment made in 1990 in a fund tracking the S&P 500® Index would have been worth more than $2.1 million by the end of 2022 had dividends been reinvested—but only $1.1 million had they not,” according to Charles Schwab research.
Obviously, 2022 ended nearly 18 months ago, but the S&P 500 is higher since then and the index’s payouts have grown over that time indicating the $1 million gap highlighted above is likely wider today than was it then.
As advisors know, dividend reinvestment works exceptionally well when the stocks in question or those in a fund to which clients are allocated grow payouts over time. That compounds the compounding proposition. That is to say there are some big benefits to dividend reinvestment, but it’s not for all clients.
When to Steer Clients Away from Dividend Reinvestment
Retirees are prime client segment for NOT using dividend reinvestment. After all, they need income in retirement confirming that if the client has substantial positions in individual stocks or funds in which payouts are being reinvested, it might be time to fine-tune those schemes or scrap them outright.
“Another case for not reinvesting dividends would be if you already have a large position in a stock or fund and don’t want to buy more of the same security. Not reinvesting dividends (and using them to invest in something else instead) can help improve a portfolio’s diversification over time,” notes Amy Arnott of Morningstar.
Not reinvesting dividends on a large position obviously makes sense from a diversification perspective and is also relevant for retirees because it can be inferred that some of the that dividend income can be used as a retirement income enhancer or shifted to less risky bonds.
When to Encourage Dividend Reinvestment
As noted above, retirees might want to consider paring or eliminating dividend reinvestment. Conversely, a young client has the advantage of time and that time benefit enhances the perks accrued via consistent reinvestment of payouts.
Translation: there probably isn’t a good reason for 30-year-old client to NOT be reinvesting dividends. Then there’s advantage of simplicity, which is appealing to advisors and clients alike.
“Another advantage of reinvesting dividends is simplicity; it’s one fewer administrative detail to remember and take care of,” concludes Arnott. “If you don’t set up your accounts to reinvest dividends, you’ll need to periodically log in to the account and decide what to do with the cash balance, such as using it to purchase another investment or transferring the proceeds to another account. Forgetting to do this is not a good idea, since dividend proceeds usually go into a low-paying ‘sweep account’ that doesn’t pay out much in the way of yield.”