Reinvesting company dividends or distributions from ETFs or managed funds is a great way to achieve solid investment growth over time.
If you own shares, exchange traded funds (ETFs) or managed funds, you may be keeping an eye on the latest round of company earnings announcements.
It’s a time when you can see how well companies are tracking, and if they’re reporting higher or lower results than last time.
But, for most investors, earnings season is also about dividends.
Because it’s the time when companies declare how much cash per share they’re going to be paying out to all shareholders in the near term.
Investors in Australian companies alone are collectively set to receive around $40 billion in dividends from the financial year ended 30 June 2022.
Then there’s additional dividends that will be paid to shareholders of international companies.
Keep in mind that company shareholders also include ETFs and managed funds, which hold hundreds and sometimes thousands of individual company shareholdings.
When company dividends are paid to ETFs or managed funds, the total amount is aggregated and then distributed down to fund unitholders based on the number of units they hold.
Making a choice
When you’re an investor in a company – either directly as a shareholder or indirectly through a fund – you generally have two options.
You can your take your dividends or distributions as cash, to spend as you like, or you can choose to reinvest your dividends to buy additional shares or fund units.
The first option obviously gives you extra spending power.
Yet, there’s strong evidence that investors who consistently reinvest will achieve significantly higher investment returns over the longer term compared with investors who choose to take their distributions as cash.
That reflects the compounding growth that can be achieved over time by having a higher investment balance. As your balance grows, so do your investment returns.
The table below provides good context around the solid investment growth that can be achieved by reinvesting income distributions over time.
The table shows how much a starting investment of $10,000 made into eight different types of assets back in mid-1992 would have been worth at the end of June this year.
The total numbers assume that all the income received from distributions along the way was reinvested back into the same asset. They don’t include any buying costs or taxes.
The average annual returns from the different asset types – Australian shares, international shares, United States shares, Australian property securities, international property securities, Australian bonds, international bonds, and cash – are quite varied.
However, the moral here is that reinvesting all distributions over time, regardless of the asset class, will achieve long-term compound growth.
On the other hand, taking distributions such as share dividends in cash will invariably erode the benefits of those compounding returns, especially over the longer term.
Easy ways to reinvest
Reinvesting company dividends or distributions from ETFs or managed funds is relatively easy.
In respect to company dividends, many listed companies offer dividend reinvestment plans (DRPs) that allow investors to have the cash value of their distributions converted into additional shares.
This conversion is generally done at the market price on the day the company pays out its dividend.
DRPs can usually be selected through the share registry company that’s used by the listed company to manage its customer records, including changes in share ownership and dividend payments.
The advantages of selecting a DRP option are that the overall reinvestment process is automatic.
Likewise, ETFs and managed funds usually provide reinvestment options either as a default or opt-in investment feature.
Where automatic reinvestment plans are not available, fund investors can readily redirect cash received from distributions straight back into their investments by purchasing additional units.
Either way, choosing to reinvest distributions is a proven strategy for building long-term wealth.
Our investment team is ready to help you accomplish your financial goals and needs. Feel free to send us an email at info@centramoney.com.au or give us a call at 08 82314709.
Article courtesy of Vanguard
