Most people are familiar with the concept of compounding interest, but dividend reinvestment is another powerful strategy for growing a retirement investment account. Reinvesting cash dividends to buy more shares can significantly boost retirement savings and returns, making it a helpful addition to a retirement plan.
Dividend reinvestment is a straightforward process. Investors can either receive cash dividends or instruct the mutual fund or broker to reinvest them automatically to purchase additional shares. For instance, if the closing price of a mutual fund on the dividend payment date is $11.00, and the per-share dividend is $1.10, the reinvested dividends of 10 shares would buy one more share.
Suppose at age 60 in 2005, you had invested $10,000 in Chevron and then spent the next 20 years reinvesting dividends (totaling $24,654). The value of your Chevron stock would have grown to $65,181 — a 522% increase. If you had opted instead to take the dividends in cash (totaling $15,745), your shares would be worth $30,799 for a total return of 365%.
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Advantages of dividend reinvestment
- Shares acquired by dividend reinvestment don’t incur a commission or fee.
- The increase in the value of a mutual fund holding usually accelerates with the ownership of additional shares.
- Dividend reinvestment is a form of dollar cost averaging, the practice of buying a similar number of shares regardless of the price per share. Research has demonstrated this practice can decrease volatility.
When to avoid dividend reinvestment
The dividend reinvestment strategy may not be for you in the following scenarios.
- You’re nearing retirement or already receiving distributions from a retirement account. You should evaluate your need for income versus your need for continued growth. You could opt to maintain dividend reinvestment for some securities and receive cash dividends on others.
- An investment is performing poorly. You should evaluate whether to retain the position or cease dividend reinvestment.
- Keep in mind that since dividend reinvestment increases the number of shares held, you will need to rebalance your portfolio periodically.
Note: This item first appeared in Kiplinger Retirement Report, our popular monthly periodical that covers key concerns of affluent older Americans who are retired or preparing for retirement. Subscribe for retirement advice that’s right on the money.
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