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I’ve been thinking a lot about the automatic versus manual reinvestment issue, and my thinking on the subject has been moving fast. So I wanted to post some thoughts and get other opinions.
I’ve always treated new money (fresh money going into my brokerage account from my paycheck) and reinvested money (dividends!) differently. In the master spreadsheet for my dividend growth portfolio, I list the purchases I’ve made since starting the portfolio.
For example, 5 times over the years, I bought 50 shares of JNJ with new money – a total of 250 shares with out-of-pocket money. Each of those transactions is listed in the “purchases” area of my spreadsheet. In another part of the spreadsheet, I track how many shares of JNJ I own now. Reinvesting JNJ dividends bought me another 22 shares over the years. So I now own 272 shares of JNJ. I have not tracked the separate purchase of those additional 22 shares (dates, prices, etc.), however, because it was not “new” money. That was dividend reinvestment, and so I’ve thought about those 22 “extra” shares as part of the “return” on the initial outlay of money for the original 250 shares.
I am starting to think that this may be a very poor conceptual framework, however. When JNJ pays me a dividend, it is just as much “my money” as the money I earn in my paycheck. And reinvesting that money back into more JNJ shares is just as much a purchase decision as when using “new” money. The only difference is that in one case – the dividends – I decided in advance that the dividend would be used to buy more shares of JNJ, regardless of the share price at that moment.
This is a hard realization for me, because it implicates my concept of “returns” on my dividend growth stocks. Until now, I’ve been looking at it this way (using made-up numbers):
I bought 250 shares of JNJ for $15,000. Those initial 250 shares are now worth $20,000, for a return of 33% – just on the shares I initially purchased. With reinvestment, I’ve got 272 shares worth $22,000, for a return of over 45%.
But this is nonsense, I am now thinking. Those “extra” 22 shares were not “extra” at all. They were purchase decisions with “my money” just as much as the original 250 shares, and I should track and think about them in exactly the same way. And it will change the apparent returns. This will require a mental and spreadsheet overhaul. I am not excited about tracking every single dividend payout and reinvestment, but I think I may have to go down that road if I really want an accurate picture.
Thoughts appreciated!
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I prefer a 10,000' view. How much have I invested (cash or DRIP), what's it worth now.
Total return is really the goal for me with dividends providing the security blanket when prices have dropped so that i can continue to hold for the long haul instead of dealing with the undulations.
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I'm more of the same opinion of your initial view on reinvestment. Cash dividends produced by your initial invested capital are part of your returns and should be counted as such.
Just as buying shares in a company that does not pay dividends but rather reinvests capital in growing the business or makes stock buybacks to grow EPS for shareholders, I look at reinvested dividends kind of the same way. If I make the initial decision to spend money on a dividend paying stock, everything that stock produces is part of the return, whether its capital gains, dividends, or extra shares.
(11-26-2013, 06:14 PM)Kerim Wrote: But this is nonsense, I am now thinking. Those “extra” 22 shares were not “extra” at all. They were purchase decisions with “my money” just as much as the original 250 shares, and I should track and think about them in exactly the same way. And it will change the apparent returns. This will require a mental and spreadsheet overhaul. I am not excited about tracking every single dividend payout and reinvestment, but I think I may have to go down that road if I really want an accurate picture.
On my spreadsheet I have a section for for each stock I own, with two sections:
1. Initial Shares Bought, date, price, #shares, total cost.
2. Beside those entries I have a section for Dividend Re-investment, with date, price, #shares and total cost.
At the bottom, about 200 rows down I add the totals and record my Totals shares, Totals cost and my Average cost of the shares.
I record the dividend re-investment each quarter for each stock I own. I also consider the dividend as part of my Total Investment ( or as new money invested).
I also count the reinvested dividends as part of my return. Otherwise, my dividend payers would have a much worse rate that what they really do.
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12-04-2013, 02:05 PM
(This post was last modified: 12-04-2013, 02:28 PM by TomK.)
To help me think about this, here is a REALLY crude example:
In scenario 1, I buy $10,000 worth of stock XYZ, yielding 5%, and after three months I get my first dividend of $125. Let's assume the share price does not move at all. I reinvest (with no transaction costs) that $125 into more shares of XYZ, so after three months, I have $10,125 worth of XYZ.
Scenario 2 is the same, except that instead of reinvesting the $125 dividend back into more shares of XYZ, I take that money and initiate a new position into stock ABC, which also yields 5%.
In either case, I am in the exact same position financially: after 3 months, my $10,000 worth of stock has turned into $10,125 worth of stock. In scenario 1, however, it looks like my $10,000 has "grown" to $10,125, for a three-month return of 1.25%. In scenario B, it looks like my initial $10,000 has just sat there flat, and I happen to have a new small investment in another company.
The $125 is either part of the return on the initial investment or it isn't, regardless of whether it gets reinvested in XYZ, buys new shares of XYZ, or sits in your account as cash. It seems a mistake to say that is counts as "return" only if automatically reinvested back in the company that issued it.
So with all that said, I think I have to see it the way Kerim and cannew present it. Shares bought with dividends (whether reinvested or put into other stocks) have to be treated the same as "new money."
That said, tracking and accounting all that does get tricky. Cannew's system sounds good, but with only 35 stocks, you're looking at tracking 140 transactions a year just for dividends! I guess there are worse problems to have, though!
EDITED TO ADD: I guess one real question is how do you track the return on stock XYZ when you take the dividends as cash and/or invest them elsewhere.
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(12-04-2013, 02:05 PM)TomK Wrote: To help me think about this, here is a REALLY crude example:
In scenario 1, I buy $10,000 worth of stock XYZ, yielding 5%, and after three months I get my first dividend of $125. Let's assume the share price does not move at all. I reinvest (with no transaction costs) that $125 into more shares of XYZ, so after three months, I have $10,125 worth of XYZ.
Scenario 2 is the same, except that instead of reinvesting the $125 dividend back into more shares of XYZ, I take that money and initiate a new position into stock ABC, which also yields 5%.
In either case, I am in the exact same position financially: after 3 months, my $10,000 worth of stock has turned into $10,125 worth of stock. In scenario 1, however, it looks like my $10,000 has "grown" to $10,125, for a three-month return of 1.25%. In scenario B, it looks like my initial $10,000 has just sat there flat, and I happen to have a new small investment in another company.
The $125 is either part of the return on the initial investment or it isn't, regardless of whether it gets reinvested in XYZ, buys new shares of XYZ, or sits in your account as cash. It seems a mistake to say that is counts as "return" only if automatically reinvested back in the company that issued it.
So with all that said, I think I have to see it the way Kerim and cannew present it. Shares bought with dividends (whether reinvested or put into other stocks) have to be treated the same as "new money."
That said, tracking and accounting all that does get tricky. Cannew's system sounds good, but with only 35 stocks, you're looking at tracking 140 transactions a year just for dividends! I guess there are worse problems to have, though!
EDITED TO ADD: I guess one real question is how do you track the return on stock XYZ when you take the dividends as cash and/or invest them elsewhere.
You could also look at it as you have a $10,000 portfolio that yields 5% and after your first quarter you collect $125 in dividends, which causes your portfolio to have a gain of 1.25%. You are right, it doesn't matter whether you reinvest it into the same shares it was produced by or into a new position, but it is still growing your account size and should be looked at as a gain not as new money coming in.
The difference in my opinion from yours is that the asset is producing income for you and you are not working and taking from your own funds to add to the position. So it is a net gain, not "new money" you are putting in.
Pretend that I spend $1 and buy a bean and plant it, and at the end of the year I harvest 100 beans from it. Then the next spring I plant those 100 beans and produce 10,000 beans with them.
Is my gain from the $1 investment in the initial bean 9,999 beans or just 99 beans? Or is it a total loss since I no longer have that original bean?
You are correct, it gets tricky accounting with a large portfolio!
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Nice posts, folks. These are exactly the questions I am wrestling with. I think cannew has it right from a spreadsheet perspective, but Tom's “edited to add” question is dead on, too.
Your "beans" point is a good one, Eric, and on point, but there is a variant with stocks, since with stocks you can take the fruit of the first bean plan and grow berries with it. To wit: If I take the dividends from XYZ and invest them in ABC, and then ABC pays dividends, are those subsequent ABC dividends part of the “return” on my initial investment in XYZ? I think most people would say no. But that would be no different than counting all dividends reinvested back into XYZ as part of the “return” on the original investment, which I think many dividend growth investors are comfortable with. To me those seem like inconsistent positions.
Maybe the right thing to do is simply sum the dividends paid from each position as part of the “return.”
Or maybe I am overthinking this and should join NilesMike at the 10,000 foot level. Perhaps it is enough to keep score by tracking the overall portfolio value and the amount of income it produces. If they are increasing at a good clip (especially the latter), you’re on the right path.
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I understand the desire to really microanalyze the returns, one can get carried away IMO.
If you take dividends from ABC and buy XYZ, it's the same as putting new money in XYZ. Otherwise you are now mixing returns from both stocks and how does that really help understand your returns? How does XYZ's performance ever get measured?
I got a headache! 
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Hmmm. This is making my brain hurt a little bit. I generally think of "returns" as measured from the moment that you buy a stock. But I also see the arguments here that the dividend reinvestment is a new purchase. I guess I'm going to have to go off and do some reading/thinking about what "return" actually is conceptually and how to measure it.
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I consider mine "returns". Just a personal choice I guess. To me this is one of the main benefits of a DG strategy. More stable returns and extra compounding because of the dividend reinvestment.
TomK you made no mention of the commission to invest the 125 in another stock, while there is no cost to re-invest in the same stock. To get the max growth the dividend re-investment should allow for fraction of share purchase.
(12-04-2013, 02:05 PM)TomK Wrote: I guess one real question is how do you track the return on stock XYZ when you take the dividends as cash and/or invest them elsewhere.
If I took the $125 cash dividend and invested in another stock, than those funds would add to the new investment.
I mainly monitor the income each stock generates and my yield on the total investment in each stock (I do not compare my return or loss to any index or market). Therefore the $125 would increase my investment in the other stock while my investment would remain the same for the initial stock.
The $125 dividend received would still be recorded as income from the first stock. Next qtr both stocks would generate an income.
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