What are the benefits of reinvesting your dividends?

8/11/2016


The goal for investing is for our money to grow. When we put our money into an investment; our goal is to have that money grow within a certain period of time. Whether it’s a short-term or long-term investment, the goal for the money is that it will be way more than it is at the initial investment stage.

Reinvesting-Your-Dividends

One smart way to take full advantage of the power of long-term investing is by reinvesting your dividends through a dividend reinvestment plan (DRIP).  This can be an advantage, because it happens automatically and eliminates the possibility of investor error.

The question is, what are your options when it comes to the dividends that your investment has yielded? Do you go on a spending spree, or do you reinvest it? There could be good reasons to spend all your dividends, and on the other hand, good reasons not to spend the dividends. Note that no option is automatically better than any other.

That means that it is up to you, the investor, to choose what’s best for your money, by answering the question: what do you do with dividend payments?

If your sole purpose of investing is income generation, then you’ll probably go with the option of spending your dividends and not reinvesting them. That is often an easy answer. However, keep in mind that this is not always your only option.


Ask yourself this: how much of the dividends do I actually need for my income? This implies that if your investment has yielded way more than you need, then this is a chance for you to spare part of the dividends to reinvest for larger yields.

On the other hand, if your sole purpose of investing is just to grow the extra money you have, then you could reinvest that money so you can earn more interest.

When you reinvest dividends immediately after receiving them, you are essentially starting the compounding process. This compounding process is particularly powerful when you reinvest dividends from a company that grows them over time. Your dividend will snowball and grow because of that. Waiting to reinvest for a few years, could prove costly in the long run. The only reason that you might not want to reinvest distributions automatically is if the underlying security is grossly overvalued.

Are there exceptions to this rule? Sure. If you’re retired and require the income to live off of, then reinvesting the dividends may not be appropriate for you. But just know that the longer your time horizon and the more you reinvest your dividends, the greater your returns should be in the long run. Investing builds wealth. The more you invest, the greater the opportunity for returns. That’s why you’re invested in the first place, right?

Things to keep in mind

In a DRIP you have no control over your purchase price. If you think one of your stocks is getting "expensive" and another is more attractive, your DRIP will still purchase shares of the expensive stock at an inflated price. Over time, the aforementioned benefit of rand-cost averaging will work out in your favour, but you do give up some control over your investing by enrolling in a DRIP. Also, keep in mind that even though your dividends are immediately used to buy more shares, they still count as dividends for tax purposes.

When you reach the stage where you’d prefer to use your dividends to supplement your income, you can simply stop reinvesting the dividends and start spending them!

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