With the proliferation of income-oriented private market fund structures like non-traded REITs and BDCs, we are often asked whether it’s better to opt for a Dividend Reinvestment Plan (DRIP) or just take the cash distributions. Our answer is that it’s not so much a matter of which is better, but rather which is more appropriate for the investor.
In short, if an investor has an immediate need for or behavioral tendency to take out the cash distributions, then doing so can be a great way to return tangible dollars back to their pockets. We have found this option to be especially helpful during times of market uncertainty as this is when investors most often flee to perceived certainty. However, if they do not have an immediate need or better use for the cash, it may make more sense to reinvest the distributions. Similar to reinvesting stock dividends, DRIP can be a powerful tool to compound returns over time.
Let’s use a hypothetical example to illustrate. Suppose an investor holds a position in a non-traded BDC with a 9.5% annualized distribution rate paid out monthly. We generally see three paths the client can take:
- Cash: Take out the cash distributions and hold in a checking account (earning 0%)
- Cash + invested: Take out the cash distributions and reinvest them in a money market (earning 4%) or some other liquid investment
- DRIP: Reinvest the distributions back into the fund
Assuming the fund’s NAV grows at 2% per year, 10-year total returns1 for each option could look like:
Growth of Hypothetical $1M
Earning 3x an investor’s money in 10 years using DRIP on a BDC rivals the best drawdown private equity strategies.2
If an investor does not need the cash and cannot put distributions to work at a higher rate elsewhere, DRIP can potentially be an easy way to let dollars compound in the background. Other investors may prefer to clip the coupon and forgoing the compounding value. In any case, should circumstances or preferences change, most non-traded REITs and BDCs allow investors to easily change between the two.
For professional investors who wish to test out more assumptions and scenarios, please feel free to contact us at [email protected].
