Author Topic: Does automatic reinvestment of dividends count?  (Read 2760 times)

Fields of Gold

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Does automatic reinvestment of dividends count?
« on: November 13, 2018, 08:12:17 PM »
If an investor adds $1000 once each month into one mutual fund located in a taxable account, then that equals $12,000 invested annually, with no selling/buy backs.

The fund's dividends were $2,000 for the year and were automatically reinvested back into the same fund.

When asked how much s/he invests per year in the fund: is the answer $12,000 or $14,000?
« Last Edit: November 13, 2018, 08:15:32 PM by Fields of Gold »

SwordGuy

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Re: Does automatic reinvestment of dividends count?
« Reply #1 on: November 13, 2018, 08:26:37 PM »
Technically both answers are correct.

But I would, in normal conversation, say I invest $12,000. 

Because next year, I'll still be adding $12,000 but the dividends will be different.  Plus I don't really know what the dividends will be until after I'm paid them.  So to answer the other way with full accuracy I would have to pay attention to all that.

It's easier to just deal with it as a $12,000 investment.

FIREball567

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Re: Does automatic reinvestment of dividends count?
« Reply #2 on: November 13, 2018, 08:27:58 PM »
I would say$12k because that's the amount you contributed.


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terran

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Re: Does automatic reinvestment of dividends count?
« Reply #3 on: November 13, 2018, 09:11:51 PM »
If you're trying to use this for "simple math" style calculations to estimate time to FI then don't count dividend reinvestment as that's already factored in via return assumptions which typically assume reinvested dividends.

AccidentalMiser

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Re: Does automatic reinvestment of dividends count?
« Reply #4 on: November 13, 2018, 09:16:42 PM »
Interesting question. 

In reality, you're simply saving the step of collecting the dividends and sending them back to buy more shares.  If you took them and invested the $2000 in a different stock, would you say you invested a total of $12k that year? 

Having said that, if someone asked how much I invested in the company this year, I would probably say "12k plus reinvested dividends."

flipboard

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Re: Does automatic reinvestment of dividends count?
« Reply #5 on: November 13, 2018, 10:21:59 PM »
12k

The 2k dividends are part of the returns, not part of the investment.

Andy R

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Re: Does automatic reinvestment of dividends count?
« Reply #6 on: November 14, 2018, 12:47:11 AM »
Dividends do not equal company earnings.

Say you buy $100 of shares in each of company w, x, y, and z, and say their earnings are all 8% this year. They will pay part of this out as dividends and retain part of it to grow the business.

Company w pays out 2% and retains 6%. Your total return is now $106 worth of shares plus $2 dividends for a total value of $108

Company x pays out 4% and retains 4%. Your total return is now $104 worth of shares plus $4 dividends for a total value of $108

Company y pays out 0% and retains 8%. Your total return is now $108 worth of shares plus $0 dividends for a total value of $108

Company z pays out 12% and sells down 4% of its assets to meet this. Your total return is now $96 worth of shares plus $12 dividends for a total value of $108

If somehow you still don't understand how completely meaningless dividends are, maybe these explanations will help.
https://www.cnbc.com/2016/12/08/dont-buy-in-to-the-dividend-fallacy-new-academic-paper-warns.html
https://www.bogleheads.org/wiki/Why_did_my_fund_unexpectedly_drop_in_value
https://www.bogleheads.org/forum/viewtopic.php?f=1&t=258311

marty998

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Re: Does automatic reinvestment of dividends count?
« Reply #7 on: November 14, 2018, 01:00:24 AM »
Dividends do not equal company earnings.

Say you buy $100 of shares in each of company w, x, y, and z, and say their earnings are all 8% this year. They will pay part of this out as dividends and retain part of it to grow the business.

Company w pays out 2% and retains 6%. Your total return is now $106 worth of shares plus $2 dividends for a total value of $108

Company x pays out 4% and retains 4%. Your total return is now $104 worth of shares plus $4 dividends for a total value of $108

Company y pays out 0% and retains 8%. Your total return is now $108 worth of shares plus $0 dividends for a total value of $108

Company z pays out 12% and sells down 4% of its assets to meet this. Your total return is now $96 worth of shares plus $12 dividends for a total value of $108

If somehow you still don't understand how completely meaningless dividends are, maybe these explanations will help.
https://www.cnbc.com/2016/12/08/dont-buy-in-to-the-dividend-fallacy-new-academic-paper-warns.html
https://www.bogleheads.org/wiki/Why_did_my_fund_unexpectedly_drop_in_value
https://www.bogleheads.org/forum/viewtopic.php?f=1&t=258311

This is not how it works in practice for listed companies. This is how it works only if you value a company on a net asset / book value basis, which is common/usual for investment funds (your vanguards and the like) - and it bears pointing out these are not really value generating enterprises.

In reality, the market will apply an earnings multiple (taking into account growth rates and discount rates) to the forecast profit to generate a value that is higher or lower than book value.

So while a company might pay a dividend of $4 and retain $4 of earnings, your (non-index or mutual fund) investment will not necessarily be worth $104. It will be worth what the market believes the sum total of its future profitability is worth.

With respect to the original question, I believe the answer is $14k.

This is simply because you have $14k of purchases through the year. A dividend may be analogous to a withdrawal, but it is not a withdrawal.

An old tax analogy comes to mind about trees and fruit. (This was taught to me in a tax law course and is relevant when determining whether a receipt is income or capital in nature - capital is something that produces income).

A tree is capital. You plant it and it bears fruit (dividend income). With dividends you are simply taking fruit. You want to reinvest (plant another seed) and you end up with more trees.

You want to make a withdrawal you have to cut down the tree.
« Last Edit: November 14, 2018, 01:11:07 AM by marty998 »

Andy R

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Re: Does automatic reinvestment of dividends count?
« Reply #8 on: November 14, 2018, 01:11:19 AM »
This is not how it works in practice for listed companies. This is how it works only if you value a company on a net asset / book value basis, which is common/usual for investment funds (your vanguards and the like) - and it bears pointing out these are not really value generating enterprises.

In reality, the market will apply an earnings multiple (taking into account growth rates and discount rates) to the forecast profit to generate a value that is higher or lower than book value.

So while a company might pay a dividend of $4 and retain $4 of earnings, your (non-index or mutual fund) investment will not necessarily be worth $104. It will be worth what the market believes the sum total of its future profitability is worth.

Yes it was a simplification to explain that earnings are not dividends. If we followed on with your example, the same point is made - the market bases the value on (projected) earnings, earnings are not dividends and dividends are meaningless.

An old tax analogy comes to mind about trees and fruit. (This was taught to me in a tax law course and is relevant when determining whether a receipt is income or capital in nature - capital is something that produces income).

A tree is capital. You plant it and it bears fruit (dividend income). With dividends you are simply taking fruit. You want to reinvest (plant another seed) and you end up with more trees.

You want to make a withdrawal you have to cut down the tree.

I would say that is the most accurately way to explain how property investing works and the most inaccurate way to explain how shares work.
When you buy one or two expensive properties, sure you can not cut off a door to sell it when the rental income does not meet your needs. This would be the closest to your analogy of having to cut down a tree to make a withdrawal.
Wish shares, you don't have to cut down the tree. Money is fungible. As per my previous example, in all 4 situations the end value will be be no different based on how much dividends are paid out.
« Last Edit: November 14, 2018, 01:23:59 AM by Andy R »

marty998

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Re: Does automatic reinvestment of dividends count?
« Reply #9 on: November 14, 2018, 02:26:46 AM »
This is not how it works in practice for listed companies. This is how it works only if you value a company on a net asset / book value basis, which is common/usual for investment funds (your vanguards and the like) - and it bears pointing out these are not really value generating enterprises.

In reality, the market will apply an earnings multiple (taking into account growth rates and discount rates) to the forecast profit to generate a value that is higher or lower than book value.

So while a company might pay a dividend of $4 and retain $4 of earnings, your (non-index or mutual fund) investment will not necessarily be worth $104. It will be worth what the market believes the sum total of its future profitability is worth.

Yes it was a simplification to explain that earnings are not dividends. If we followed on with your example, the same point is made - the market bases the value on (projected) earnings, earnings are not dividends and dividends are meaningless.

An old tax analogy comes to mind about trees and fruit. (This was taught to me in a tax law course and is relevant when determining whether a receipt is income or capital in nature - capital is something that produces income).

A tree is capital. You plant it and it bears fruit (dividend income). With dividends you are simply taking fruit. You want to reinvest (plant another seed) and you end up with more trees.

You want to make a withdrawal you have to cut down the tree.

I would say that is the most accurately way to explain how property investing works and the most inaccurate way to explain how shares work.
When you buy one or two expensive properties, sure you can not cut off a door to sell it when the rental income does not meet your needs. This would be the closest to your analogy of having to cut down a tree to make a withdrawal.
Wish shares, you don't have to cut down the tree. Money is fungible. As per my previous example, in all 4 situations the end value will be be no different based on how much dividends are paid out.

You are misusing this totally overused phrase. Money is fungible but the number of shares/units you have in the company matters (your share of the pie). So selling a share (reducing your proportion of ownership) is different to a dividend - where everyone is paid equally and your proportionate ownership stays the same.

Andy R

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Re: Does automatic reinvestment of dividends count?
« Reply #10 on: November 14, 2018, 03:21:06 AM »
You are misusing this totally overused phrase. Money is fungible but the number of shares/units you have in the company matters (your share of the pie). So selling a share (reducing your proportion of ownership) is different to a dividend - where everyone is paid equally and your proportionate ownership stays the same.

Sorry I'm not following. How does it differ if you own 1/1000th of a $1m company or 1/100th of $100k company?
And following from that, if a company grows from a 100k company which you own 1/100th of to a million dollar company and you sell down along the way until you own 1/1000th of the million dollar company, how would it be any different to you?

jacoavluha

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Re: Does automatic reinvestment of dividends count?
« Reply #11 on: November 14, 2018, 06:11:13 AM »
The literal answer to the original question is $14k. That is your basis in the investment.

If you sold your shares after dividend reinvestment, at a value of $14,010, your capital gain will be $10. Not $2,010.

Dances With Fire

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Re: Does automatic reinvestment of dividends count?
« Reply #12 on: November 14, 2018, 06:18:00 AM »
12k

The 2k dividends are part of the returns, not part of the investment.

This^^^ Good answer.

Count the dividends as part of your total return. Yes you will be "buying" more shares, but at a reduced NAV.

Boofinator

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Re: Does automatic reinvestment of dividends count?
« Reply #13 on: November 14, 2018, 07:44:54 AM »
If somehow you still don't understand how completely meaningless dividends are, maybe these explanations will help.
Yes it was a simplification to explain that earnings are not dividends. If we followed on with your example, the same point is made - the market bases the value on (projected) earnings, earnings are not dividends and dividends are meaningless.
Perhaps you meant "dividends are meaningless" in a very limited sense. Contrariwise, dividends have very real meaning in that they are one of two methods for the ultimate disposition of company profits and invested capital to shareholders (the other being a buyout (and I guess a third would be the scraps from forced liquidation)). If a company has fantastic earnings but will never pay dividends or sell out, how much should shareholders pay for a piece of that pie? (Assume no possibility for shareholder takeover.)

Andy R

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Re: Does automatic reinvestment of dividends count?
« Reply #14 on: November 14, 2018, 08:20:27 AM »
If a company has fantastic earnings but will never pay dividends or sell out, how much should shareholders pay for a piece of that pie?
Yep you are right If a company pays out no dividends, then that means the earnings that would have paid out the dividends have actually disappeared, and if a company pays out a higher percentage of it's earnings as dividends, then it means the extra dividends are free money. Thank you for clearing up how incorrect my point that dividends tell you nothing of your the total return.

Boofinator

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Re: Does automatic reinvestment of dividends count?
« Reply #15 on: November 14, 2018, 08:33:52 AM »
If a company has fantastic earnings but will never pay dividends or sell out, how much should shareholders pay for a piece of that pie?
Yep you are right If a company pays out no dividends, then that means the earnings that would have paid out the dividends have actually disappeared, and if a company pays out a higher percentage of it's earnings as dividends, then it means the extra dividends are free money. Thank you for clearing up how incorrect my point that dividends tell you nothing of your the total return.
Ok, I misunderstood you. You are correct by saying dividends don't tell you what the actual return on investment is. As I prefaced my comment,
Perhaps you meant "dividends are meaningless" in a very limited sense.

jacoavluha

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Re: Does automatic reinvestment of dividends count?
« Reply #16 on: November 14, 2018, 05:10:54 PM »
12k

The 2k dividends are part of the returns, not part of the investment.

This^^^ Good answer.

Count the dividends as part of your total return. Yes you will be "buying" more shares, but at a reduced NAV.

In the case of dividend reinvestment they’re actually both return and investment. Your basis in the investment is increased by the amount of the reinvestment.

Consider this: you own $10,000 in shares. You get a $500 dividend. You reinvest the dividend. What is your investment?

Now what if you again own $10,000 in shares. Again you get a $500 dividend. Instead of reinvesting, you transfer the funds to checking. The next day, you purchase $500 in additional shares with cash. What is your investment?

If you want to pretend that one scenario is different than the other, go right ahead.

PDXTabs

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Re: Does automatic reinvestment of dividends count?
« Reply #17 on: November 14, 2018, 05:58:09 PM »
The 2k dividends are part of the returns, not part of the investment.

It is both return, and if reinvested, investment.

With that said I would say "12K", because dividend reinvestment is one of the ways you get to ~7% return per year. So most people assume that you are reinvesting your dividends while you are saving for retirement.

Dances With Fire

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Re: Does automatic reinvestment of dividends count?
« Reply #18 on: November 15, 2018, 05:13:52 AM »
12k

The 2k dividends are part of the returns, not part of the investment.

This^^^ Good answer.

Count the dividends as part of your total return. Yes you will be "buying" more shares, but at a reduced NAV.

In the case of dividend reinvestment they’re actually both return and investment. Your basis in the investment is increased by the amount of the reinvestment.

Consider this: you own $10,000 in shares. You get a $500 dividend. You reinvest the dividend. What is your investment?

Now what if you again own $10,000 in shares. Again you get a $500 dividend. Instead of reinvesting, you transfer the funds to checking. The next day, you purchase $500 in additional shares with cash. What is your investment?

If you want to pretend that one scenario is different than the other, go right ahead.

I do agree with this. In fact I look at my total portfolio basically in the same way as you describe.

Please understand, I was trying to keep it simple for the basic question the OP was asking while trying to avoid the much debated (beaten to death) dividends vs. growth issue.

I view dividends and growth as two sides of the same coin. YMMV, "there are many roads to Dublin".

Someone pass me a pint....


theoverlook

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Re: Does automatic reinvestment of dividends count?
« Reply #19 on: November 15, 2018, 09:43:39 AM »

This is not how it works in practice for listed companies. This is how it works only if you value a company on a net asset / book value basis, which is common/usual for investment funds (your vanguards and the like) - and it bears pointing out these are not really value generating enterprises.


His examples are how a listed company's share values would react to a dividend payment. On the ex dividend date, the dividend amount is taken out of the share price. So, if the dividend is $4/share and the share value is $104, then on the ex dividend date the share value drops to $100/share. Whoever holds that share on the ex dividend date gets $4. Functionally receiving a $4 dividend is no different from selling $4 worth of stock. You are receiving a portion of your investment in the company back as cash in either case. You can argue a philosophical difference, but both cases are returning capital to the shareholder.

flipboard

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Re: Does automatic reinvestment of dividends count?
« Reply #20 on: November 15, 2018, 11:23:55 AM »
12k

The 2k dividends are part of the returns, not part of the investment.

This^^^ Good answer.

Count the dividends as part of your total return. Yes you will be "buying" more shares, but at a reduced NAV.

In the case of dividend reinvestment they’re actually both return and investment. Your basis in the investment is increased by the amount of the reinvestment.

Consider this: you own $10,000 in shares. You get a $500 dividend. You reinvest the dividend. What is your investment?

Now what if you again own $10,000 in shares. Again you get a $500 dividend. Instead of reinvesting, you transfer the funds to checking. The next day, you purchase $500 in additional shares with cash. What is your investment?

If you want to pretend that one scenario is different than the other, go right ahead.
A much clearer scenario:
- You invest 12k
- Value grows to 14k that year.

Did you invest 12k, or 14k? I think everyone would agree 12k.

Why is that different from investing 12k and receiving 2k dividends? It isn't.

By choosing to use the 2k dividends on _anything_ other than reinvesting, you are withdrawing from your investments. Dividends and growth are the same side of the coin: they're return on investment.

jacoavluha

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Re: Does automatic reinvestment of dividends count?
« Reply #21 on: November 15, 2018, 12:05:17 PM »
12k

The 2k dividends are part of the returns, not part of the investment.

This^^^ Good answer.

Count the dividends as part of your total return. Yes you will be "buying" more shares, but at a reduced NAV.

In the case of dividend reinvestment they’re actually both return and investment. Your basis in the investment is increased by the amount of the reinvestment.

Consider this: you own $10,000 in shares. You get a $500 dividend. You reinvest the dividend. What is your investment?

Now what if you again own $10,000 in shares. Again you get a $500 dividend. Instead of reinvesting, you transfer the funds to checking. The next day, you purchase $500 in additional shares with cash. What is your investment?

If you want to pretend that one scenario is different than the other, go right ahead.
A much clearer scenario:
- You invest 12k
- Value grows to 14k that year.

Did you invest 12k, or 14k? I think everyone would agree 12k.

Why is that different from investing 12k and receiving 2k dividends? It isn't.

By choosing to use the 2k dividends on _anything_ other than reinvesting, you are withdrawing from your investments. Dividends and growth are the same side of the coin: they're return on investment.

The two scenarios I presented above. What would you consider my "investment" in scenario 1? How about scenario 2?

Boofinator

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Re: Does automatic reinvestment of dividends count?
« Reply #22 on: November 15, 2018, 12:52:07 PM »
Here's a similar scenario: You invest $12k, stocks drop, you TLH at $10k. What is your investment?

To me it is pretty clear: Your investment is ∑inputs-∑outputs. This definition is pretty standard (for example, on Vanguard's performance page). The alternative to this formula would be a similar one that accounted for inflation by choosing the time period to reference the inputs and outputs and adjusting each input and output for inflation.

jacoavluha

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Re: Does automatic reinvestment of dividends count?
« Reply #23 on: November 15, 2018, 01:03:16 PM »
Granted the OP's question was vague. But to me it seems silly to consider your "investment" something different than your cost basis. And in terms of cost basis, dividends reinvested are treated no differently than de novo cash purchases.

Boofinator

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Re: Does automatic reinvestment of dividends count?
« Reply #24 on: November 15, 2018, 01:11:31 PM »
Granted the OP's question was vague. But to me it seems silly to consider your "investment" something different than your cost basis. And in terms of cost basis, dividends reinvested are treated no differently than de novo cash purchases.

True, except the money comes out as dividends. So in the ∑inputs-∑outputs formula, you'd have an output of dividends immediately followed by an equal and opposite input of the reinvested dividends. So you end up right where you started.

jacoavluha

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Re: Does automatic reinvestment of dividends count?
« Reply #25 on: November 15, 2018, 01:27:20 PM »
Granted the OP's question was vague. But to me it seems silly to consider your "investment" something different than your cost basis. And in terms of cost basis, dividends reinvested are treated no differently than de novo cash purchases.

True, except the money comes out as dividends. So in the ∑inputs-∑outputs formula, you'd have an output of dividends immediately followed by an equal and opposite input of the reinvested dividends. So you end up right where you started.

we are in agreement; some here don't seem to think that reinvested dividend dollars should count as input.

All semantics anyway. I've never had such a conversation as the OP presented anyway.