A year ago (or so) I picked up my first shares of Lorillard (LO), which have done phenomenal for me. Without going in to how many share I have, let’s do a case study and see what it’s done over that period if you decided to put your dividends back in to the stock. I’d like to do a basic and simple illustration of reinvestment.
I currently have my IRA at Tradeking, set to DRIP (Dividend Reinvestment Program), meaning that each dividend I receive is automatically put back in to the stock it came from. Tradeking does allow the purchase of partial sharesand handles your DRIP for absolutely no extra cost which is a big bonus.
I purchased in February of 2014, at $47.95. Had you bought 100 shares at that time, the company would have rewarded you with dividends totaling $250. In that time period using dividend reinvestment you would have been able to purchase 2.037 additional shares. Don’t rue the day of small beginnings. Those first couple of extra shares can create a lot of wealth given enough time.
These 4 additional shares, coupled with a dividend increase from $0.615 to $0.66 now purchase you an extra $2.64 in shares each quarter.
Now enough time hasn’t really passed to show those incredible growth curves that you get after your DRIP has bought enormous amounts of additional shares. I find those really inspiring, but sometime’s it’s good to see what a recent, small example can do for you, which is why I chose this illustration.
It’s also extremely important to understand that most brokerages do not calculate your return on investment when using DRIP’s the way I just did. For example right now my Tradeking account shows a grand total return of 39.75%. Not to shabby, but certainly not 47.25%.
Where is the disconnect? It’s actually pretty simple, but counter intuitive to how most people think. Rather than consider the dividends free money on your initial investment, it actually creates an additional cost basis for each purchased share at the time it was purchased. So instead of your cost basis remaining (100 x 47.36) it becomes (100 x 47.95) + (1.022 x 60.18) + (1.05 x 62.13) + (0.982 x 63.93) + (1.02 x 66.69).
The extra shares actually make your return look worse based on their math! That’s why it’s important to understand how dividend reinvestment really works and be able to calculate your returns on your own. In my mind, clearly the investment has gone up 47% but you will never see that on your brokerage statement.
Imagine doing this over 30 years and those first few shares that your dividends bought, compound substantially! This is the deceptively powerful compounding that putting that income back in to the shares can create given enough time.
Some other fanstastic case studies have been done by Joshua Kennon over much longer time periods. Check out:
- A 50 year case study of Coca-Cola
- 250k in Coca-Cola by 35
- A short lesson in compounding
- How grandpa could have turned his Pepsi habit in to 7 figure portfolio
- Dividends reinvested in Disney
What do you think? Do you like how I calculate return or is your brokerage doing it correctly? Do you use a DRIP, spend your dividends, or pool them together for future purchases? Drop it in the comments.
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