Thursday, October 17, 2013

Albert Einstein said...

“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.”
Honestly, I am rather skeptical that he actually did say it, but I think it is something that most people have come to believe that is true, especially when you look at the effect of exponentials on money. Nothing makes a heart beat faster than seeing money triple in that time that you would think would only make it double.

Anyway, if you have been reading my posts (I doubt it), you would know that I've modelled my ideal asset allocation portfolio to include mostly dividend paying funds, so that I can accumulate cash and allocate and rebalance more efficiently.

However, this morning when I logged into my account, I made the startling discovery that the dividend payouts due to me from my bond funds - oh horror - have been reinvested! Now, I never knew that the dividends would be reinvested, and I don't recall signing up for any reinvestment scheme, though that actually might be useful. So, I went searching around the site for an explanation, and I found the FAQ which states that

"In Phillip Unit Trust, all dividends will be reinvested, unless funds have only payout dividend option"

All right, now that sort of changes things a bit, doesn't it?

Now, I was almost just about to reach for the phone and start questioning my platform company about this, when I remembered something that I read on the Monevator's website before. The most compelling article that he wrote that quantifies his support for compounding interest (and hence, dividend reinvestment) is here. The next wonderful piece that he wrote is regarding the psychology of dividend reinvesting, which he tackles through Inc and Acc units here. Lastly, he also wrote an interesting piece about his dividend HY portfolio here.

In the first article, he strongly makes his case for starting early, due to the time factor of compounding interests. He advocates leaving your money alone and allowing dividends to reinvest. Although the effects are minuscule now, they will snowball and have a huge effect in the future.

In the second article, he advocates adopting Acc units instead of Inc units. Acc units allows you to decidedly defeat the inner demon within you that might avert you really following through your dividend reinvestment plans. By not having dividends physically coming in to play with, no wrong can be done and you won't be able to be up to any mischief. It also gifts you the gift of being disciplined without putting in any effort.

In his last article, he makes a clear distinction between an income dividend portfolio, as opposed to long term investing portfolio. I think this is really applicable to me, and a timely reminder to once again tell me that I should not be expecting my long term portfolio to be spurting out tons of income.

After re-reading his articles, I think instead of giving Phillip that call and trying to get payouts instead of reinvestment, I will just leave it as it is. 

Dividend reinvestment will
  • force feed me discipline
  • reduce my transaction costs
  • engage in passive dollar-cost averaging within my investments
  • force me to monitor payouts made and new units accumulated
  • compound my returns 

With that said, I think I will be actually looking towards opening up a SCB account to start my income portfolio, since now I have made a clear distinction between a long-term portfolio, and an income generating portfolio.

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