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    The Power of Reinvesting

    The All Share Index (ALSI) closed at an all time high on 17 January to much fanfare from market commentators and investors alike. Simplistically put, R100 invested into the ALSI (excluding the impact of all costs) at its peak on 22 May 2008 would only have risen back to the R100 level on the 17th, having been ‘underwater’ for the past 3 years and 8 months.

    Importantly this index only looks at price movements of the constituent shares and doesn’t include the effects of dividends paid out. Savvy investors that reinvested their dividends would have gained parity in November 2010, and the R100 investment in May 2008 would now be worth R112. The chart below shows the difference between the ALSI (dividends paid out) and the ALSI Total Return (dividends reinvested) since the peak rebased to 100.

    Some investors take their dividends (the yield has averaged just under 3% over the past 10 years) and use it for discretionary spending, some use it to fund their living expenses (particularly those using their dividends to fund their retirement), and others reinvest their dividends until they retire.

    Naturally investors in retirement require their dividends, but for those investors that don’t need their dividends the decision to reinvest or pay out for consumption (i.e. spent on ‘wants’ and not ‘needs’) can produce quite a large difference in the final amount invested in the market over time.

    For the purpose of this article we’ll take a look at two hypothetical investors:
    • Investor A
    o Sold his business for R1 000 000 and invested it in the stock market.
    o Started working at Company XYZ and lived off his salary.
    o Reinvested dividends consistently as they were paid out.
    o Worked at XYZ for 10 years before retiring.
    • Investor B
    o Sold his business for R1 000 000 and invested it in the stock market.
    o Started working at Company XYZ (same job and pay as Investor A) and lived off his salary.
    o Used dividends paid out as a ‘bonus’ which were spent on overseas trips and luxury electronics.
    o Worked at XYZ for 10 years before retiring.

    At retirement we now have two investors who need to make lifestyle decisions based on the income they can generate in their retirement years. The difference in savings between the two investors is actually quite staggering. The chart below shows what would have happened based on returns generated and dividends paid out of the ALSI over the past 10 years:

    Investor A would have saved up R4.1 million versus Investor B’s R3.1 million, a full R1 million difference and as such Investor A will be able to receive an income all the way through retirement that is more than 33% higher than Investor B (if both live off the same drawdown percentage – i.e. the same investment risk).

    It is apparent from this report that seemingly innocuous decisions can have such dramatic differences if repeated over an extended period. The gap between the two investors would be significantly wider (both in percentage and rand terms) the longer the investment horizon. It is therefore critical for those investors that are 20 / 30 / 40 years from retirement to keep reinvesting all proceeds in order to take advantage of the 8th Wonder of the World – Compounding.

    All the best for 2012 from the team at Seed Investments, may it be prosperous in all respects!

    Take care,

    Mike Browne
    021 9144 966

    Permalink2012-01-31, 10:28:27, by Mike Email , Leave a comment