Difference Between Growth and Dividend Reinvestment
There are two ways to make money in the market: income and growth. Income is cash payments that investors receive periodically in the form of interest income or dividends. Growth is an increase in the price of an asset over time. For example, a $20 stock may pay $1 in annual dividend income, and if the stock price increases from $20 to $25 per share, the investor's stake will grow 25 percent.
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Total Return
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Dividends are paid in cash, which investors are free to use as they see fit. For example, investor A owns 1,000 shares of XYZ at $20 per share. He receives $1,000 in annual dividends that he spends. The $1,000 is his income. If the share price increases from $20 to $25, he will also have a $5,000 growth in his account. His total return -- dividend plus share price appreciation -- is $6,000, or 30 percent on his original investment.
Dividend Reinvestment
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Dividend reinvestment helps an investment grow faster. If investor B, who also owns 1,000 shares of XYZ at $20, does not need the dividend income, he may choose to reinvest the dividends in additional shares of stock. The $1,000 in dividends will buy him 50 more shares of XYZ at $20. He will now own 1,050 shares. At $25 per share, his investment will be worth $26,250, or $250 more than that of investor A, who chose to take his dividends in cash. Investor B's total return, dividends plus share price appreciation, will be $7,250, or 36.25 percent.
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Compounding
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Simply put, compounding is earning interest on interest. Compounding accelerates growth over time. Let's say the following year the dividend remains the same and XYZ stock appreciates another 20 percent. Investor A receives another $1,000 in dividend income and the value of his stock increases to $30,000 -- for a total return of $6,000, or 24 percent. Investor B, who now owns 1,050 shares, will receive $1,050 in dividends, which will buy him another 42 shares of XYZ. He will now own a total of 1,092 shares of XYZ that at $30 per share will be worth $32,760, and his total return will be $7,510, or 28 percent.
Faster Growth
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Dividends, which constitute investment income, help an investment grow faster when reinvested in additional shares of stock.
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