Monday, 18 June 2012

The Impact of Reinvesting Dividends

The chart shows the value over time of a $100 investment made in the S&P 500 in 1925 with dividends reinvested vs. dividends not reinvested.  It appears in the book pretty much as shown below.

Dividends reinvested vs. not reinvested

It makes the difference between reinvesting dividends (the top line) and not reinvesting dividends (the bottom line) look pretty impresive, but it also makes it look like there isn't much difference until 50 years or so after the initial investment.  That's because the vertical scale is linear.

A more typical way to show compound growth such as this would be to use a semi-log chart, as shown next.  (A somewhat less serious problem with the chart above is that the horizontal scale distorts the amount of time at the beginning and end of the data.)

Dividends reinvested vs. dividends not reinvested (log scale)

  1. All that's really going on here is the difference between about 10.5% compound annualized growth (dividends reinvested, on the top line) and 5.7% compound annualized growth (dividends not reinvested, on the bottom line). 
  3. The semi-log chart (with time properly represented on the horizontal scale) makes it clear that there is constant percentage growth in the value of the investment regardless of whether or not dividends are reinvested.  That's because the lines are straight (remember that straight lines on the semi-log chart indicate consistent compound growth).         
  4. It also shows more clearly that reinvestment of dividends 
  • affects the investment value right from the beginning and
  • provides a consistently increasing benefit as more and more time passes.

1 comment:

dividend said...

Nice topic
I want to know that what is reinvesting dividend & what is the strategy that reinvesting dividend investors follow?
ex dividend