Let's look at a controversial example as to why reinvesting distributions into a falling asset is worse than simply collecting the cash distributions. $mste paid investors $6.02 a unit in distributions since inception. Many investors thought that reinvesting those payouts would lower their cost average and increase their growth potential. Some even celebrated because their share count nearly doubled over that time frame as you can see in the attached image. The math says something else though. A distribution isn't free money. It i's your own capital being handed back to you from the mutual fund or ETF. It's not a creation of new money. It is the equivalent to selling a portion of the fund yourself. When the fund kept falling, those reinvested distributions bought more shares that lost value too. The final result since inception looks like this... If you simply took the cash distributions ....$10,000 would be worth $5,508. A loss of 45% since inception! Terrible. If you reinvested all your distributions, that original $10,000 investment is now worth.... $2,833 A loss of 72% since inception! Doubly terrible!! That's a further loss of 49% compared to taking the distributions!!! 🤯 A common lie on social media is that more shares equal more wealth. More shares that are worth MORE means more wealth. More shares that are worth LESS likely means LESS wealth. This math applies for dividends being paid out by a tanking company as well. Things change if you are using a covered call product with leverage. The impacts of a falling fund are amplified by the leverage and the added cost of the fund. this can be seen when comparing $MSTR vs $MSTE. The fund lost more than the underlying in the down market. If ever there is a strong recovery, the covered call fund will not have the full capital appreciation. Hoping for a recovery is not what the fund is designed to do well at. The call options at the money or near to at the money will cap the upside will hinder the recovery even with the leverage. The key lesson is this... Reinvesting a distribution is good ... if it eventually earns a positive return. Otherwise, reinvestment simply compounds your exposure to a declining asset and gives you a false hope with a lower cost basis. Happy investing everyone! PS. This is a biggy back off of a nice post by @smallbird.financial
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🤔 Why Did Reinvestment Do Worse? | Beginner Investors | Blossom Social
