Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Reinvestment Rate

What it is:

Reinvestment rate is the rate at which an investor can reinvest cash flows from an investment.

How it works (Example):

Put simply, an investor might receive, say, a 6% dividend, but what does he do with that money when he gets it? If he chooses to invest it in a CD that pays 4%, then his reinvestment rate is 4%.

For a more real-world example, consider a Company XYZ bond with a 10% yield to maturity. In order for an investor to actually receive the expected yield to maturity, he or she must reinvest the coupon payments at a rate equal to the yield to maturity (10%). That is, she must have a 10% reinvestment rate. This is not always possible. If the investor could only reinvest at 4% (perhaps because market returns fell after the bonds were issued), the investor's actual return on the bond investment would be lower than expected.

Why it Matters:

Reinvestment rate is a common part of bond investing, but really any investment that generates cash flows exposes the investor to the need to find good reinvestment rates. The risk that the reinvestment rate will not be as high as the initial rate of return is called reinvestment risk.

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