If you invest in ASX shares, I'm sure you've wondered whether or not to reinvest your dividends. A $10,000 investment in Harvey Norman Holdings Limited (ASX: HVN) shares would be netting you a tidy $770 per year at the current dividend yield. It's a similar story for Qantas Airways Limited (ASX: QAN), which is yielding a tidy 3.80% right now. But is there a way to boost your total returns even higher this year?
Here's a quick look at the pros and cons of dividend reinvestment to help you decide whether this is an investment strategy you should adopt in 2020.
Dividend reinvestment can help boost your returns
One of the biggest factors in maximising your long-term return on investment is the magic of compounding returns. This is where reinvesting your ASX dividends can make a huge difference throughout your lifetime.
As a simple example, let's say you buy $10,000 worth of shares in the aforementioned Harvey Norman. We'll assume that the company's yearly 7.70% dividend yield remains constant, and we'll assume the stock price increases by an inflation-adjusted 5% each year.
If you just took the dividend and spent it each year, you'd receive $770 per year and in 40 years' time, those shares would be worth $70,399.89. That's a pretty handy return on your investment for a relatively small sacrifice.
However, let's do a quick example where that $770 is compounded and reinvested back into Harvey Norman shares each year. In this case, your yearly income is now $0 from the shares, but that same $10,000 investment would be worth a hypothetical $1,193,869 in 40 years' time.
The difference here is two-fold. By not spending that $770 each year, you're buying $770 more of Harvey Norman stock each year. On top of that, you would earn the hypothetical 5% gain and 7.70% dividend yield on a higher principal amount.
But it's not all that simple…
Obviously, that's a simplified example of how dividend reinvestments work. However, it does show that the maths can add up to a huge wealth difference in the long-run.
I think the key is to put your ASX dividends to best use for your own circumstances. If you think taking your dividends and using them to pay down your mortgage is a better use of your money, that could be a great option.
Likewise, if you wanted to spend the $770 each year then that could work as well. But if you're a long-term buy-and-hold investor in some high-quality ASX dividend shares, this simple decision can pay dividends in the future.
