Friday 19 October 2012

The Importance of Reinvesting Income

Source
As a DIY Income Investor you generate income - and you reinvest it, don't you, rather than spend it?

After all, this seems to be the way to become wealthy over time. And if you don't believe me, take a look at this study...

The Barclays Capital Equity Gilt Study 2012 is the latest in a long series making the same point about reinvested income. It notes that:
  • £100 invested in equities at the end of 1899 would be worth just £160 in real terms without the reinvestment of dividend income, but with reinvestment the portfolio would have grown to £22,239
  • the effect upon a gilt portfolio is less in absolute terms, but the ratio of the reinvested to non-reinvested portfolio exceeds 400 in real terms.

To a large extent this is a result of the magic of compound interest. However, this does not mean simply buy high-yield investments. You need to keep your capital secure. As Warren Buffet's Rules 1 and 2 say: Don't Lose Money! And you can lose money on shares (and fixed-income investments) for a host of reasons. So the corollary is: look for high yield with a margin of safety. In particular, look for danger signs like poor cashflow, swelling pension deficits, falling market share, increased debts, and lack of competitiveness.

And this is the tricky part. This is why you need to spend time read, think, ponder and consider potential investments. This does require some effort, compared to letting someone else make these decisions (i.e. investing in a fund or a trust).

But the logic seems pretty convincing to me: generate income safely and reinvest it.


Update 18/11/12: For a challenging alternative view of this approach, see Retailinvestor.org.


I am not a financial adviser and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.

4 comments:

  1. Like, I know you have a whole bunch of disparate websites, but this kind of utterly generic non-article drives me away rather than makes me come back. Better not to post.

    That said, past articles containing more specific ideas have been very welcome. You've already got the disclaimer about not being an adviser, fine. Chesnara was a good bet, also SEGRO not too bad.

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    Replies
    1. Hi TulipCraze

      You are probably right but in the post I am struggling with the logic of a basic justification for income investment - if the bulk of stock market returns are due to reinvested dividends, does that mean that buying non-dividend shares is - on balance - less likely to produce long-term returns, because capital growth, on average, produces much less return that reinvested income?

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    2. OK - let's look at an established Value Investor viewpoint : "the correct value of a stock is the exactly the value of its future income stream adjusted to current value".

      I believe it, and to me that means choose income over growth, because growth is harder to spot (don't know about you, but my crystal ball keeps going on the fritz). The trouble with that in the current market, is that lots of people are thinking the same way and pushing up the price (depressing the yield) of said income stocks. Also, the value of the currency continues to depreciate thanks to QE. So what to do? High yield income stocks are the answer: I think there is still value to be had *at acceptable risk* in the PIB, Pref and Bond sector. The "acceptable risk" part is key here: and can only really be achieved through diversification i.e. having a bunch of them. A look at the Model Portfolio on FixedIncomeInvestor would be a good place to start.

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  2. Very thoughtful words, thank you and hope that you will give us more information soon. It is a pleasure to have this type of important information. Keep it up please.

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