I am a huge believer in reinvesting dividends.
What does that mean exactly? It means I use the money that companies like Microsoft and Chevron pay me four times a year on each share that I own — that is called a dividend — to buy more stock in those companies.
I don’t use it to buy sports tickets. No new kitchen counters. No car. I just reinvest that cash and buy more stock.
Why is this good? Because when that stock price goes up (and it eventually will if it is a good company), those shares I bought are worth more.
The coolest part of reinvesting dividends is when a company’s stock price drops and you can buy those shares on the cheap. That happens all the time. And if you stay in the game over the long term, it can turbo-charge your returns.
I experienced it myself when Microsoft sagged into the $20s for what seemed like forever.
All the while, I was reinvesting those dividends. I’ve done the same with BP, whose stock price has struggled for the better part of a decade since the Deepwater Horizon disaster.
Check Microsoft these days. It was worth the wait. It’s in the $80s.
Wharton professor Jeremy Siegel has written entire books based on reinvesting dividends. I have faithfully read them.
Warren Buffett is fond of saying that when the price of hamburger goes down, people flock to the meat counter for more. The same should be true of stocks.
The accompanying charts illustrate the difference between your return if you reinvest dividends (also known as “total return”) and if you don’t. One includes the difference in the Dow Jones industrial average index of 30 stocks with and without dividends. The other includes Standard & Poor’s 500-stock index by the same measures.
Daniel P. Wiener, chief executive officer of Adviser Investments, a Newton, Mass.-based firm that manages more than $5 billion in assets, put together the data to reinforce the power of total return compounding.
“The biggest lesson here is that dividends count,” Wiener said. “When investors are told that an index has gone up X percent, that’s not the same thing as being told its total return.”
“When investors look at their account statements, they don’t just see prices,” he said. “They see prices plus dividends plus interest: total return.”
The charts drive home the point, but there’s another stark reminder in these numbers.
Since the dark days of the global financial crisis of 2007-08, the Dow and S&P have hit a combined 357 all-time highs. The two indexes go down a lot, which is why they don’t hit new highs every day.
But the 357 number does not include dividends. If you add in dividends, then the dynamic duo has hit more than 500 new highs since we sunk into the fateful Great Recession.
“When the newspaper and radio people and TV people talk about the Dow and the S&P, they are giving you an index number, not a total return number,” Wiener said. “Day to day, those dividends don’t account for much, but over time, they account for a lot.”