One misconception I frequently encounter among investors is that dividends are somehow free money. In reality, when a stock goes ex-dividend, its share price theoretically adjusts downward by the amount of the upcoming distribution, all else being equal.
If the share price subsequently recovers, that’s a separate economic event. The dividend itself hasn’t created additional wealth. It has simply transferred cash from the company to its shareholders.
Dividends are simply one way for management to return capital to investors. If a company doesn’t have sufficiently attractive opportunities to reinvest in its operations, make acquisitions, or repurchase its own shares, it might decide to distribute excess cash and let shareholders decide what to do with it.
That doesn’t make dividends unimportant. They can form a meaningful component of total return, particularly when they’re reinvested. That’s the basic principle behind a dividend reinvestment plan (DRIP). Let’s look at a historical example using an S&P 500 index fund.
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How dividend reinvestment works in practice
For this exercise, I’ll use the U.S.-listed iShares Core S&P 500 ETF (NYSEMKT: IVV), which tracks the S&P 500 Index of large American companies. IVV charges an exceptionally low 0.03% expense ratio and currently has a modest 0.95% 30-day SEC yield.
That yield is relatively low compared with historical levels for the U.S. stock market. One reason is the growing influence of large technology companies, many of which prefer to allocate substantial amounts of capital toward business expansion, artificial intelligence infrastructure, research and development, and share repurchases rather than paying large dividends.
However, IVV is a useful example precisely because dividends represent a relatively small portion of its current investment profile. Even modest distributions can make a substantial difference when reinvested over long periods.
To demonstrate this, I ran a historical backtest using Testfolio covering May 19, 2000, through October 14, 2026, a period of approximately 26.4 years. We started with $10,000 invested in IVV and made no additional contributions. I then compared two scenarios: one where every dividend was taken as cash and another where every dividend was reinvested into additional ETF shares.
Without dividend reinvestment, the original $10,000 grew to $54,945. That represents a cumulative return of 449.5%, or an annualized return of 6.7%. With dividends reinvested, however, the same initial investment grew to $87,804.51. The cumulative return increased to 778.1%, while the annualized return rose to 8.6%.
That’s approximately $32,860 more in ending portfolio value, despite starting with exactly the same amount of money and never contributing another dollar. The difference comes from compounding.
Every reinvested dividend purchases additional shares, which then participate in future market appreciation and generate their own distributions. Over time, those additional shares can make an increasingly meaningful contribution to portfolio growth.
It’s also worth noting that this comparison focuses on ending invested portfolio value. In the non-reinvestment scenario, the investor would have received cash dividends along the way, which still have economic value even though they weren’t included in the final balance.
Don’t forget about taxes and account placement
This backtest assumed dividends were reinvested consistently without trading costs, or cash left over. In practice, brokerages offering DRIPs can automate much of this process, although some plans only purchase whole shares while others support fractional shares.
Second, the comparison assumes no taxes were deducted from the distributions. That’s particularly relevant for Canadians investing in U.S.-listed ETFs such as IVV, which usually get hit with a 15% foreign withholding tax on dividends.
Under the Canada-U.S. tax treaty, eligible U.S. dividends paid directly into a Registered Retirement Savings Plan (RRSP) are generally exempt from the usual 15% U.S. withholding tax. That makes an RRSP an attractive place to hold U.S.-listed dividend-paying ETFs.
A Tax-Free Savings Account (TFSA), by contrast, does not receive the same treaty exemption. U.S. dividends paid into a TFSA are generally subject to 15% withholding before reaching the account, reducing the amount available for reinvestment.
For Canadian equity ETFs holding Canadian dividend-paying stocks, a TFSA can be an excellent choice because eligible distributions and investment gains can compound without Canadian income tax.
