Q: There are some who say dividends should be reinvested, whereas there are others who say it is better not to reinvest. What is your opinion...
Q: There are some who say dividends should be reinvested, whereas there are others who say it is better not to reinvest. What is your opinion?
A: The odds favor reinvesting the dividends. There are several reasons for this. The first is that dividends play a much larger role in long-term returns than most investors think. According to the Ibbotson Associates yearbook on asset returns, for instance, capital appreciation contributed 5.9 percent of the 10.4 percent annualized compound rate of return on large common stocks from 1926 through 2004. The remainder, 4.5 percent, came from dividends and their reinvestment. This assumes automatic — and free — dividend reinvestment in shares.
Another benefit of dividend reinvestment is that it is a form of dollar-cost averaging. Your dividends will buy more shares when the stock price is down than when it is up. Automating the process makes you into a savvy “buy low, sell high (or never)” kind of investor. Think Warren Buffett.
Utility-stock investors, for example, suffered a great deal in the 1970s as interest rates rose and stocks’ price-to-earnings multiples fell. Electric utilities were so desperate for capital that most offered generous dividend-reinvestment plans. A shareholder who reinvested dividends could buy additional shares at a discount of 5 to 6 percent off the market price.
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Eventually, utility-dividend yields were running at a rate of 6 to 8 percent as P/E ratios fell below 10. When interest rates peaked and the market started to turn in 1981, utility stocks provided stunning returns.
Many analysts would add a caveat to these comments, pointing out that what happened in the past may not be repeated in the future. Dividend yields are dramatically lower today, for instance, than they were during most of the 1926-2004 period measured by Ibbotson Associates. Similarly, many corporations suppress dividends today, believing it is better to buy back shares. This works to increase earnings per share and allows investors to sell shares to realize income only when they need it.
The hardest part of your question is the horse-race aspect. If you don’t reinvest your dividends in the stock that issued them, you’re betting that the stock you buy with those dividends — one of more than 6,000 domestic stocks — will do better than the stock that’s paying the dividend. If you are confident about investing your dividends in a new stock, you need to reconsider whether you want to own the one that pays the dividends.
Q: I worked during high school and college, and not just during the summers. The money I saved all went to pay for college. Since then I have had a lot of trouble saving money. I finally was able to purchase my first home at age 35. I’m now 37, with $25,000 in credit-card debt and a mortgage on a home that needs work.
Any extra money I get now needs to go toward fixing up my home or paying off credit cards. If I had bought a certain piece of property 10 years ago, it would now be worth a million dollars. I wish I had never gotten into debt. Can you give me some help?
A: Life is full of might-have-beens and hard choices. Many readers would be happy to regale you with the full details on what a house they sold in 1970 — or 1975, 1980, 1990 or even 2000 — is worth today. Some people have sold homes that have appreciated more in the past four or five years than they have earned at their job.
It’s quite possible that you are focusing on the wrong thing. Instead of thinking your house is going to make you rich, or at least less cash-poor, I suggest that you start paying close attention to where you spend your income. Most people can find ways to reduce expenses. Software such as Intuit’s Quicken or Microsoft Money makes it pretty easy.
One thing you might discover when you put your spending under a microscope is that owning a house isn’t doing much for you and that you could cut expenses by renting.
Questions about personal finance and investments may be sent to Scott Burns at The Dallas Morning News, P.O. Box 655237, Dallas, TX 75265; by fax at 214-977-8776; or by e-mail at firstname.lastname@example.org. Questions of general interest will be answered in future columns.