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I recently got a question on my blog asking whether it’s better to cash in dividend checks or reinvest them.
It’s a great topic, and I have a very definitive answer: If you’re an income investor who could really use the dividends to live right now, by all means cash those checks.
However, if you can afford to reinvest your dividends, by all means consider doing so.
After all …
Dividend Reinvestment Is One of the Most
Powerful Wealth-Building Strategies Out There!
It’s no secret that I consider dividends one of the best wealth-building tools in the world of investing. But I consider the effect of compounding to be equally powerful.
As you know, compounding takes time, as the money you’ve already earned on your investments begins to earn returns of its own.
For example, if you put $10,000 into a savings account with a 6% annual interest rate, you’ll have $10,600 after one year. Next year, you’ll be earning 6% on the $10,600 rather than just the original $10,000.
That might not seem like a big deal, but the effects can really add up over time. Ten years later, you’d have almost $18,000, 80% more than you started with!
With dividend reinvestment, you’re combining both concepts into one mega-force. And if anything, the compounding is even more accelerated. Here’s why:
You’ll be steadily increasing your holdings of a particular stock over time, setting yourself up for even more dividends down the line.
As various studies have proven, dividend reinvestment is responsible for much of the market’s historical performance.
In fact, asset management company Eaton Vance says as much as 65% of U.S. stock gains have come from reinvested dividends!
And when I worked for Standard & Poor’s, the company did a study that sliced and diced the S&P 500 stock index. Here’s what they found:
Over a 20-year period, capital gains would have produced a 381.9% gain. Not bad. But reinvesting dividends would have turned that gain into a 905.1% windfall.
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So as you can see, dividend reinvestment is a smart move.
The even better news is that reinvesting your dividends doesn’t have to be a complicated process. In fact …
When Properly Set Up,
Dividend Reinvestment
Is Automatic and Free
Hundreds and hundreds of companies are more than glad to help long-term investors buy additional shares with their dividends, so they’ve created Dividend Reinvestment Plans (or DRIPs) to make the process easier.
Here are some pointers on DRIPs:
- In some cases, the company runs the plan itself. Most times, however, the plan is run by an independent agent.
- While a few plans allow you to buy your initial stock directly, most require you to be a current shareholder.
- Many plans also allow you to buy additional shares with your own money; and some will even automatically deduct a set amount from your checking or savings account at predetermined intervals.
- A select number of plans even allow you to purchase your shares at a discount (generally between 1% and 10%) to the stock’s current market price. Talk about a deal!
Now, before you sign up for one of these plans, please note that if you don’t plan on participating for at least a few years, it’s probably not worth the hassle.
Okay, you own a dividend-paying stock and you want to reinvest your dividends. How do you get started?
First, find out whether a company offers a DRIP plan. You can contact its investor relations department to find out. They’ll be happy to provide you with the necessary forms and/or the plan agent’s phone number.
These days, you can also find much of the information on third-party websites. One very useful site is www.computershare.com. This company acts as the plan administrator for hundreds of DRIP plans and their website allows you to search by company name. Another valuable resource is www.moneypaper.com, which offers many of the same features.
If your company offers a plan, you simply sign up for the plan by phone or online. Then, the company itself or its plan agent will automatically reinvest your dividends into additional shares. If they allow additional purchases, they can also help you set up automatic deductions from, say, your savings account.
If your company doesn’t offer a DRIP, don’t despair. There are still ways to efficiently reinvest your dividends. Many brokers will do it at no charge. And if they won’t, you can always switch over to a broker that acts like a DRIP plan. One such service can be found at www.sharebuilder.com.
What about mutual funds and ETFs? Many funds will automatically reinvest dividends for you. And although exchange-traded fund investors are typically responsible for reinvesting any dividends they receive, your broker might be willing to do it for free. So don’t be afraid to ask.
Bottom line: I think reinvesting dividends is the right choice for most investors. I don’t know of a better way to steadily increase a portfolio’s value over the long haul.
Best wishes,
Nilus
P.S. Most of the recommended companies in Dividend Superstars offer DRIPs. So if you’re looking for some new income ideas, I encourage you to subscribe today for just $39.
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