What will your dividends actually pay you?

Yield on cost, and why it drifts

The yield quoted on any stock is the dividend divided by today's price, so it describes what a new buyer would receive. Yield on cost divides the same dividend by what you paid, however many years ago. If the payout grows, those two numbers separate steadily: a holding bought at a 3.5% yield whose dividend grows 6% a year is paying roughly 10% on the original cost after twenty years, even while still quoting 3.5% to anyone buying it fresh.

It is a genuinely useful number for judging a long-held position, and a genuinely misleading one for judging a new purchase. Yield on cost says nothing about whether the holding is worth owning today — only about how well the past decision has aged.

Why reinvesting compounds twice

Reinvestment adds shares, and if the dividend per share is also growing, each of those new shares pays more than the last ones did. The two effects multiply rather than add. That is why the difference between taking dividends as cash and reinvesting them is usually far larger than people expect over twenty or thirty years — and why the tax rate matters more than it appears, since tax is taken before reinvestment and therefore reduces the compounding itself, not merely the income.

A high yield is not automatically good

Yield is a fraction with price on the bottom, so it rises whenever the price falls. A stock yielding 9% when its sector yields 3% is usually not a bargain — it is a market forecast that the dividend is about to be cut. The uncomfortable arithmetic is that a dividend cut takes the income away and tends to take the price down with it, so the high yield never actually gets paid. A moderate, well-covered dividend that grows reliably generally produces more income over a decade than a high one that gets reduced.

What this model deliberately does not do

It assumes constant growth rates and no dividend cuts, which no real company delivers. It ignores currency effects on foreign holdings, withholding tax on overseas dividends, and the fact that reinvestment in reality happens in whole shares at varying prices. Treat the output as a way of understanding the shape of dividend compounding, not as a prediction of a balance.

Worked example: $50,000 invested at a 3.5% yield, with the dividend growing 6% a year, the share price growing 4% a year, dividends reinvested and taxed at 15%, over 20 years. Year one pays $1,488 after tax. Year twenty pays $8,516. Total income received across the period is $80,220, the portfolio finishes at $215,815, and the yield on original cost has reached 17.0% — against the 3.5% a new buyer would still be quoted.