Reinvestment

Reinvestment is the retention of interest, dividends, or earnings within the investment in order to accumulate capital value or enhance future earnings. For securities, reinvestment is the use of dividends due to the investor to purchase further shares of the same investment. Perhaps the most commonly recognized type of reinvestment is the compounding of interest; by allowing the interest earned to remain rather than withdrawing the interest when it is due, the resulting principal and retained interest will earn still more interest, increasing the total amount earned on the investment.

Most companies engage in dividend reinvestment in order to maintain or replace aging equipment, acquire new properties or securities, or to pay down existing debt. These activities do not produce immediate results, but add to the long-term potential for earnings of the company. Paying down corporate debt is especially useful for most companies since it reduces the amount of outstanding liability on the balance sheet, eliminates a portion of the interest payments due on that debt, and typically improves the company’s credit rating and stock value.

Capital Reinvestment


Capital reinvestment is especially important in the corporate world, since it provides the needed influx of operating capital for continued production and expansion. A company that returned 100% of its earnings to its shareholders would soon lag behind in production capacity and see its facilities and equipment fall into disrepair. Sustaining capital reinvestment is the amount of profit that a company must retain in order to maintain its capital assets; this reduces the amount returned to shareholders in the form of dividends, but is essential for the continued existence and earnings potential of the company. Investors typically expect a certain amount of reinvestment in order to maintain the quality of their principal investment and ensure the company’s overall operating health.

Dividend Reinvestment Plans


Some companies offer direct dividend reinvestment plans to their investors; these plans allow shareholders to build equity within the company more rapidly than would otherwise be possible. Because these plans automatically apply earned dividends to the purchase of additional shares of stock rather than distributing them to the shareholder, the investor’s equity in the company grows with every dividend distribution. Typically, these plans require direct ownership of the stocks in question, rather than proxy ownership through an investment brokerage. Dividend reinvestment plans typically feature very low minimums required for participation and relatively high annual maximum investment limits. Since shareholders do not need to use a broker to purchase additional shares, the fees associated with these services are significantly reduced.

Diversified Reinvestment Funds


Reinvestment funds are specialized mutual funds that allow their members to roll scheduled dividends back into the funds rather than receiving them as earned income. These funds combine the convenience of a managed plan with the quick equity building power of individual dividend reinvestment plans. This allows the shareholders of reinvestment funds to quickly amass a sizable equity stake and provides them with a diversified position in the market. By packaging the dividend reinvestment plan of numerous companies into one reinvestment fund, the risk to investors is significantly mitigated.
Tim Ord
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