Balance your budget
It’s about the
little things
Article: Chris Nel
Analyst, Kruger International
Email: [email protected]
Telephone: 011 726 7700
When discussing the secrets to
successful long-term investing,
investment managers will invariably
say that the reinvestment of dividends
is a vital component.
C
lassic cartoons invariably have two characters,
our budding hero – and that other guy who,
despite several cunning plans, just never quite
manages to catch his nemesis. Envision the
Road Runner and Wile E. Coyote. Investors
are similar: there are those who understand the secrets to
smart investing and those with numerous “brilliant” ideas
that rarely materialise into anything.
When discussing the secrets to successful long-term
investing, investment managers will invariably say that the
reinvestment of dividends is a vital component. For the
example below, we will again use the Old Mutual Investors
Fund, one of the few existing equity funds with a trackrecord long enough to cover the time period.
The date is 1 January 1976. Frank and Joe, two 25-yearolds, want to start saving for their golden years. Their
parents, impressed by their foresight, give them each the
enormous sum, at the time, of R10 000-00, as opposed to
buying them each a sports car. Frank and Joe hear that a
share investment is the most effective way to grow a longterm investment and they each complete the forms to start
their investment with their lump sum of R10 000-00. At the
bottom of page three is a box marked “Re-invest Dividends”.
Joe, the more diligent of the two, has read every page twice
and decides it is best to mark this box. Frank, on his way out
of the office for the weekend, fails to notice this box and
leaves it blank.
Three months later Frank and Joe receive their first
investment statement which shows that their investments
have grown nicely. Frank also gets a fine surprise: a cheque
for a few Rand. Jubilant, Frank realises that the investment
he made a few months ago is buying him a beer tonight! Joe
smiles at him and peruses his statement to ensure that his
few Rands in dividends have been reinvested.
Forty years later, Frank has been on a golfing to ur to
Ireland and has kitted out his bar at home on the dividends
received, deaf to Joe’s claims that he should be reinvesting
his dividends to make his investment grow better. On
31 December 2015, their day of obligatory retirement,
Frank reviews his statement and sees that his investment
has grown to R3 537 459-00, which equates to a 15,8% per
annum average return on his investment, in addition to
those nice little bonuses he received every few months.
Ecstatic, Frank manages to wangle a glance at Joe’s
investment statement and almost faints in shock. The
reason is that Joe’s investment has grown to R15 834 10400, a 20,3% per annum average return. Frank cannot believe
that reinvesting dividends has resulted in Joe’s investment
being worth 5 times as much as his own.
Joe sits his friend down and explains the process as
follows: Each time the fund paid dividends, Joe used his
dividends to buy more units in the fund, which then
increased the total units that he owned in the fund. His next
dividend would then increase to reflect the greater number
of units held. This snowball-like cycle would repeat, with the
net effect being that Joe’s investment has become worth
a lot more than Frank’s. In fact, 78% of Joe’s return on his
investment is directly attributable to the fact that he chose
to reinvest his dividends.
Imagine if Wile E Coyote had this kind of snowball… and
if the cartoons were longer than 5 minutes.
*Dividends in this article are assumed to mean all
income received from the investment, excluding the
effect of price movement. Performance numbers
exclude the effect of taxes.
Maart/April 2016 / March/April 2016
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