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What Are Dividend Reinvestment Schemes?

Depending on which study you read, dividend reinvestment is either very important to the long term returns to an investor or very, very important.

However, it is very difficult for a small scale, individual investor to do. If you only hold a few hundred or a few thousand shares in a company, the annual dividend payment can often be lower than the total dealing cost to reallocate the new money. Or if it is above that cost, it might still eat up the majority of the payment, making any reinvestment financially unappealing.

Recognising this, many larger companies with tens or hundreds of thousands of shareholders now operate something often called a DRiP. This is a Dividend Reinvestment Plan. Rather than be sent your annual cheque, the firm will purchase as many additional shares as the money will buy at very low dealing costs.

By arranging such a scheme for thousands of investors at a time with a stockbroker, they can use economies of scale to keep the dealing fees as low as possible. This is important since the 'drag' of fees is one of the main impediments to a successful portfolio.

The money will almost certainly have any relevant taxes automatically deducted before it is applied (usually some form of dividend withholding tax which depends upon where the investment is located and where you are personally resident, and any stamp duty required by law as a part of the purchase), but it allows the little guy to reap some of the same advantages that were previously only open to funds and major corporations.

The main attraction of dividend reinvestment is the potential for a compound return on interest. This is very powerful and every investor should want to harness the power of compounding . Earning a growing amount of 'interest' (your return) on a growing amount of interest is a beautiful thing!

By reinvesting dividends, more shares are bought each year. These new shares will also produce an income stream which can be used to purchase more shares in future years. Over time, this has the power to make a significant improvement to the value of a holding. And, as we read from the likes of Warren Buffett, time is a very important factor in long-term investment.

To quote Charles D. Ellis from his excellent book Winning The Loser's Game, too many investors buy and sell far to often and instead should follow his maxim, "Don't just do something, stand there!" to really let the power of compounding work for their holdings.

If the holding is also increasing in value at the same time, this will provide an impressive improvement in performance. A combination of an increasing number of shares plus an increasing stock price and - hopefully - an increasing annual dividend payment will do wonders for your portfolio. We hope that you one day see such a combination!

Please follow this link to see how one major UK stockbroker handles this for their private investor clients.

To read more about dividend related subjects, follow these links:

To An Investor, A Dividend Is A Valuable Thing!

The Definition Of A Dividend

Dividend Policy And Dividend Cover

Understanding And Calculating A Dividend Yield

How High Is A High Dividend Yield?

What Is Your Dividend Tax Rate?

Building A Dividend Portfolio

How Does An Annual Dividend Payment Policy Alter A Company Stock Price?

How Does A Scrip Dividend Work And What Is A Scrip Issue?