Dividend Re-Investment Options

Introduction

As we learned previously, dividend re-investment is one of the key ingredients in the “secret sauce” of dividend growth investing. As it provides an additional layer of compounding, it’s one of the main drivers of total returns on the whole stock market. In this lesson, we’ll explore dividend reinvestment options for dividend growth investors. We’ll discuss various options and the pros and cons of each to help you make informed decisions about your dividend reinvestment strategy.

Dividend Reinvestment Plans (DRIPs)

A Dividend Reinvestment Plan (DRIP) allows investors to automatically reinvest their dividends into additional shares of the same stock. Many companies offer DRIPs, either directly or through a transfer agent, that enable investors to buy fractional shares and avoid transaction fees.

Pros:

  1. Automatic reinvestment: DRIPs ensure that your dividends get reinvested automatically, allowing you to take advantage of compounding without the need for manual intervention.
  2. Fractional shares: DRIPs enable you to buy fractional shares, ensuring that your entire dividend is reinvested, even if it’s not enough to purchase a whole share.
  3. Reduced fees: Many DRIPs charge no fees or minimal fees for dividend reinvestment, which can save you money compared to purchasing shares through a brokerage.

Cons:

  1. Disregards valuation: Dividends are re-invested regardless of the current valuation and it’s distance from the company’s intrinsic value.
  2. Limited diversification: With DRIPs, you can only reinvest dividends in the same stock as the dividend-paying company. This can limit your ability to diversify your portfolio.
  3. Tax considerations: Dividends reinvested through a DRIP are still taxable, even though you don’t receive them as cash. This means that you will need to account for taxes on reinvested dividends when filing your tax return.

Brokerage Reinvestment Programs

Many brokerages offer their own dividend reinvestment programs, which are similar to company DRIPs but with some added flexibility. These programs allow you to reinvest dividends from multiple stocks into a single account, enabling you to diversify your investments more easily.

Pros:

  1. Diversification: Brokerage reinvestment programs offer greater diversification, as they allow you to reinvest dividends from multiple stocks into your choice of investments.
  2. Convenience: With a brokerage reinvestment program, you can manage all of your investments in one place, making it easier to track your portfolio’s performance.

Cons:

  1. Disregards valuation: Dividends are re-invested regardless of the current valuation and it’s distance from the company’s intrinsic value.
  2. Fees: Some brokerages charge fees for their reinvestment programs. It’s essential to compare fees across different brokerages to ensure you’re getting the best deal.

Manual Reinvestment

Manual reinvestment involves collecting your dividend payments as cash and then using that cash to purchase additional shares of stocks or other investments. This option gives you the most control over your reinvestment strategy, but it also requires the most effort.

Pros:

  1. Flexibility: Manual reinvestment allows you to choose the best investment options for your portfolio at any given time, taking valuations into consideration.
  2. Control: By reinvesting dividends manually, you can decide when and where to invest, giving you greater control over your portfolio’s growth.

Cons:

  1. Effort: Manual reinvestment requires more effort than automatic reinvestment options, as you must actively monitor your portfolio and make investment decisions.
  2. Fees: When reinvesting dividends manually, you may incur transaction fees for buying additional shares, which can eat into your returns.

Conclusion

Dividend reinvestment is a vital aspect of dividend growth investing. By understanding the different options available, you can choose the best approach for your investment goals and preferences. Whether you opt for a DRIP, a brokerage reinvestment program, or manual reinvestment, the key is to stay disciplined and committed to your long-term investment strategy to maximize the power of compounding dividends.