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 hod 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.

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.

The money will almost certainly have any relevant taxes automatically deducted before it is applied, 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.

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.

If the holding is also increasing in value at the same time, this will provide an impressive improvement in performance.