Reinvesting dividends is a simple concept. Instead of taking your dividend payout in cash you take it in stock (in the same company).
Reinvesting Dividends: The Pros
The positive reasons to reinvest dividends:
- Your next dividend is larger (because you now have more shares).
- If you’re just getting started, you dividend payment is likely to be small in absolute terms. Even a high dividend yield of 4% pays out only $4/year for every $100 invested. Investing $1000 gets you $40/year or $10/quarter (the most common dividend payment schedule). While it might be nice to have another $10 in your pocket, it’s not life-changing. You won’t miss the $10 a quarter in cash and will be amazed at how over the course of a few years dividends will accumulate.
Reinvesting Dividends: The Cons
This list is going to be longer but weaker. They’re really more excuses than “cons.”
- You still have to pay taxes on dividends even when you reinvest them. Of course, it’s not likely to change your tax payment in any meaningful way, so who cares?
- There’s a lot of paperwork to keep track of because you have to pay the dividend taxes and then track how much each share costs (so each time you reinvest dividends, that’s another thing to track). Again, who cares? Your brokerage will track this for you automatically.
- Many brokerages (like Robinhood) don’t support reinvesting dividends or if they do, don’t support buying fractional shares (meaning, if your dividend payment isn’t large enough to buy a whole share of stock they won’t let you buy a fraction of a share). Ok… find one that does. If your concern is that Robinhood is free, Stockpile only charges about a $1 transaction commission and doesn’t charge anything for reinvesting.
Of course, points #1 and #2 above only matter if you’ve invested using taxable accounts. If you eventually like what you learn on this site, and use money in an IRA to invest this way, taxes don’t matter until you withdraw money from the account (if it’s a regular IRA) or never (if it’s a Roth IRA).
A while ago I wrote a very popular e-book on dividend reinvesting. In fact, in reviewing it as I write this post, I’m still proud of the content and unique point of view. You should have a look:
In short, reinvesting dividends means taking your dividend payments as more stock instead of cash. More stock means more future dividends, so your dividend paycheck grows over time. This is what is meant when someone talks about compounding. The more something grows, the more it continues to grow. When you compound something, time is your best advantage. The further out in time you go, the larger the compounding effect.
For someone getting started dividend payments are small and won’t make a difference in your quality of life or your tax obligation. Reinvesting them puts your wealth accumulation on auto-pilot. I just don’t see any downside to