Keeping it simple: dividend reinvestment

Aiming for a success of stock market investing is often less about identifying tomorrow’s big winners, and more about getting the basics right. Regular investment in a diversified portfolio is a more realistic long-term strategy than trying to find the next world-beating technology company. Dividend reinvestment is a straightforward option to support the growth of your investments over time. 

How does it work? Many investment trusts pay a dividend, with the average yield across the sector sitting at 3.3% . For many trusts, paying a regular and growing dividend to their shareholders is as important an objective as growing capital. There are a range of trusts with a long history of growing their payouts to shareholders through all types of financial market conditions. 

You have a choice on how you receive that dividend. You can take the cash, or you can reinvest it to buy more shares. This service is available through investment platforms, or through a Dividend Reinvestment Plan (DRIP) usually available through an investment trust’s registrar. If you choose to buy more shares each year, your shareholding gets a little bigger. You then receive dividends paid from that larger shareholding. Reinvested shares effectively earn their own future dividends. This creates a virtuous circle, helping to grow your portfolio steadily over time. 

Over time, this compounding effect may be significant. Take a hypothetical portfolio of 100 shares, with a current value of £1,000. The trust declares a dividend of 4% (equivalent to £40) and the investor chooses to reinvest it in more shares. They now have 104 shares, valued at £1,040. That doesn’t sound particularly impressive, but making the same reinvestment year after year compounds the effect. After a decade, the investor would have around 150 shares. Even if the share price hasn’t moved at all, an investor would still have seen their investment grow to £1,500, and their dividend would be worth £60 a year. 

Add in capital growth and the effect is stronger. While capital growth can’t be guaranteed, Evelyn Partners analysed the performance of the FTSE 100 over the last forty years to 2025. Over that period, it made a capital return of 391%. But with UK dividends reinvested the total return hits a vastly higher 1,926% . While it can feel like a real bonus to have a regular dividend landing in your bank account, the sensible long-term strategy is likely to be a dividend reinvestment plan. 

You can also benefit from pound cost averaging. This is usually discussed in the context of making regular investments in the market, but also applies to dividend reinvestment. If the share price is low, an investor’s dividend payment will buy more shares. If it is high, it will buy fewer, but the investor will have made some capital gains. In this way, it can help smooth out returns over time, providing some insulation against market volatility. 

How to do it

Most investment platforms have a dividend reinvestment option for the investment trusts held on them. Equally, investment trust company share schemes will also offer you the option to reinvest rather than take dividends as cash. Usually, it is just a question of ticking a box, but every platform is different. Once this is done, there are no further decisions to make – every time an investment trust pays a dividend, the platform will automatically buy more of the same investment. If you don’t do it, your dividends will simply be paid into the cash account on the platform, or directly to your bank account if that is what you have requested. 

There are a number of factors to consider when reinvesting dividends. The first is tax. Dividends are taxable whether you take them as cash or reinvest them in more shares. Investors’ first priority should be to use tax-sheltered investment options such as an ISA or SIPP, particularly for higher rate taxpayers. Within both wrappers, dividends are tax free, so you get to keep the full amount, and the effects of compounding are greater. Reinvested dividends still make sense outside a tax wrapper, but you will need to account for additional tax on your annual return. 

Another consideration is cost. Platforms will often make a charge to reinvest dividends, as they would with a normal share transaction. Some platforms give a much-reduced price for reinvesting dividends – less than £1 in some cases. With others, you may be paying standard share dealing costs. This can eat into the compounding effects of dividend reinvestment.  If reinvestment is a priority, it may be worth choosing a platform that makes the process simple and cost-effective. The Association of Investment Companies (AIC) provides a useful comparison of automatic dividend reinvestment fees charged by many of the UK’s most popular investment platforms, available here. 

Dividend reinvestment is a straightforward option to build a potential larger holding in an individual investment trust. Over time, reinvesting dividends has proved a powerful way to improve the compounding effect of stock market investment. For those who don’t need the income from their investments for day-to-day spending, it is an option worth considering.

Important information

Risk factors you should consider prior to investing:

• The value of investments and the income from them can fall and investors may get back less than the amount invested.

• Past performance is not a guide to future results.

• Tax treatment depends on the individual circumstances of each investor and be subject to change in the future.

• If you require advice please speak to a qualified financial adviser.

Other important information:

Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG, authorised and regulated by the Financial Conduct Authority in the UK.

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