By John Drachman
Investments that generate income like this present the kind of challenge most investors would love to have: What to do with all of that money. The answer though leads to a fork in the road: in one direction, reinvesting those dividends may lead to a bigger payday later. In the other direction, taking the cash has its own attractions.
What are stock dividends?
Profitable companies often use some of their monies to pay a dividend to shareholders as a reward for their investment support. The more shares, the higher the payment received. While there is no guarantee that a given stock or mutual fund will rise over time, reinvestment of dividends has the potential to make a good portfolio better. However, there are also good reasons to take payments in cash.
The Upside of Reinvestment
Reinvesting dividends has a proven track record:
- The magic of compounding Albert Einstein is said to have called “the power of compound interest the most powerful force in the universe.” By reinvesting dividends in additional shares of an investment, you have a chance to compound returns over the long-term.
- Easy to set up: Investors can either reinvest their dividends on their own or let a Dividend Reinvestment Plan (DRIP) do it automatically.
- Consistent approach: Such plans also let you take advantage of Dollar-Cost Averaging; that is, using your payments to buy more shares when they’re cheap and fewer shares when they’re pricey.
- Inexpensive way to grow wealth potential: Because reinvestment is automatic, you don’t have to pay additional commissions or brokerage fees.
The Joy of Cash
There are also times when it’s better to take dividends in cash:
- Spending money: Those approaching retirement for example are looking to gradually shift their portfolios from wealth accumulation to generating regular monthly income. For those without other major sources of income in the pipeline, dividend income will likely be needed to help fund retirement.
- Share prices head south: If an investment has stalled out beyond its normal daily price swings, pocketing the dividends could be the smarter choice. When a dividend-paying investment struggles too hard to stay afloat, it can unbalance a portfolio and create future problems.
- Diversify into something else: Taking dividends in cash also gives you the freedom to invest elsewhere to increase diversification and potentially lower your risk exposure.
The Bottom Line
Although dividend reinvestment can help your investment to keep growing, it’s not a one size fits all solution. Remember to validate your investment assumptions with a licensed investment professional first to avoid possible regrets later. Do you want to discover more about the role stock dividends can play in a portfolio? Also check out MPFA’s Stock Dividend Consistency and the Pandemic.
John Drachman is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. John is an IABC award-winning writer, who applies his 30 years of financial marketing experience toward advancing the dialog between investors and investment professionals.