Continuing on my series of posts around dividend investing here is another one.
With the recent slowdown in economy starting 2008, interest rates started falling short term borrowing interest rates have been near the 0% mark. Average certificates of deposit rates in the US have slumped, with current 1 year CD yielding around 0.9% average annually (according to bankrate.com) . During these times investors look for more return to their money and start investing in dividend yielding stocks. Capital /principal and steady dividend yielding is what investors look for during this time.
The purpose of this post is to check if dividend investing make sense when the interest rates are higher , the economy is doing well and CDs yield more.
Let us start with an example of the recent past. According to this source for this historical CD data Between 2003 to 2007 average one year CDs yielded anywhere between 2.0 to 5.4% annually respectively falling to 3.9%, the average being 4.0% . A CD return is one of the safest investments where the principal is guaranteed not to change.
During the same time let see the yield if a hypothetical investor had put money in the total stock market fund like VTI.
VTI started 2003 with a share price around 42 and finished around the same price by the end of 2008. During this time it gave dividends of 69 c in 2003 to a max of $1.15.
The yield on the above is anywhere from 1.6% to little over 3% and surely not beating the yield of CD. The capital / principal increase was almost negligible for this period.
The reason I selected VTI was to select one of the most stable or non risky investments in the stock market compared to the CD. I did not bring dividend re-investing or compounding interest in my calculations.Yes, one could argue that they could beat the market with another selection of stocks.
I did not compare selection during earlier bull markets however.
What are your thoughts? Are there more ways of looking at these scenarios.
Showing posts with label dividends. Show all posts
Showing posts with label dividends. Show all posts
Wednesday, July 20, 2011
Friday, July 8, 2011
Dividends: Dividend reinvesting calculator
I have seen some investment gurus always mention how good a dividend re-investment strategy could be. Recently I have been following some dividend stock blogs and am a dividend investor myself.
Always interested in mathematics I was curious how the numbers add up and what the compound rate of return would be under different scenarios. Let us start with a simple example:
Investment capital : $1000
Stock Price: $1
Yield : 5%
Dividend growth rate: 5%
Time span: 5 years.
I used the calculator here.
Total value of this portfolio without dividend reinvested would be $1580.88 and with dividend reinvested would be around $1,648.38. The net yield is 9.51 vs 10.51 respectively.
Lets play around with some numbers. Increasing the timespan to 20 years which is typically realistic with dividend or long term investors we can see the difference: 7.4% vs 10.5%.
If the stock price remains the same for 20 years with no variation one can get 5.16 vs 8.35 % for reinvested dividends.
Now if the stock price is 10% down annually in a timespan of 5 years then the ROI for the reinvested dividends is -3.43 which is lesser than -3.16. In my example if I set the stock price move to 5% down annually for 10 years then the dividend reinvestment scheme still proves better.
Overall I feel like a dividend investor should have an exit strategy just like any other investor. If the fundamentals for the company look good then reinvesting in a downtrend might be risky but worth it.
Before I forget, there is a definite tax advantage to these reinvested dividends which is a separate topic itself. But the flip side is that calculating cost basis for re-invested dividends could be time consuming.
What is your re-investment strategy? From most of the examples above it seems that re-investment does make sense unless ofcourse you want free cash flow.
Always interested in mathematics I was curious how the numbers add up and what the compound rate of return would be under different scenarios. Let us start with a simple example:
Investment capital : $1000
Stock Price: $1
Yield : 5%
Dividend growth rate: 5%
Time span: 5 years.
I used the calculator here.
Total value of this portfolio without dividend reinvested would be $1580.88 and with dividend reinvested would be around $1,648.38. The net yield is 9.51 vs 10.51 respectively.
Lets play around with some numbers. Increasing the timespan to 20 years which is typically realistic with dividend or long term investors we can see the difference: 7.4% vs 10.5%.
If the stock price remains the same for 20 years with no variation one can get 5.16 vs 8.35 % for reinvested dividends.
Now if the stock price is 10% down annually in a timespan of 5 years then the ROI for the reinvested dividends is -3.43 which is lesser than -3.16. In my example if I set the stock price move to 5% down annually for 10 years then the dividend reinvestment scheme still proves better.
Overall I feel like a dividend investor should have an exit strategy just like any other investor. If the fundamentals for the company look good then reinvesting in a downtrend might be risky but worth it.
Before I forget, there is a definite tax advantage to these reinvested dividends which is a separate topic itself. But the flip side is that calculating cost basis for re-invested dividends could be time consuming.
What is your re-investment strategy? From most of the examples above it seems that re-investment does make sense unless ofcourse you want free cash flow.
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