Does Dividend Reinvestment Pay?

by: Dividend Growth Investor October 10, 2008    

Dividend Growth Investor

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One of the components of every stock analysis I have done at my blog has always been to show the effects of dividend reinvestment over a ten year period of time. The results are truly amazing as the dividend income with reinvestment almost always outpaces the dividend income without reinvestment.

The main pro of re-investing your dividends is that you get the power of compounding in your favor. You are essentially getting “free shares” by investing the total dividend income into more stock. If you have also picked a solid stock that tends to increase the payments to stockholders every year you are essentially turbo charging your portfolio for the long run and should expect to receive even faster annual dividend raises.

Another reason for re-investing dividends is that one could dollar cost average their dividend income into more stock by spreading their purchases over a period of time, which also decreases risk.

The past decade was definitely a good time to be re-investing your dividends in Realty Income (O).


One con for dividend reinvestment is that you still get taxed on the income that you receive. Another thing that the investor holding stocks in a taxable account should do is keep a very through bookkeeping of their activities in order to efficiently file their tax returns for the year.

One of the major reasons why people are hesitant to do dividend reinvestment however could be that instead of purchasing new assets or enjoying their dividends, they are adding onto a single investment which could go bankrupt. Chances are your company might fail leaving you with a lot of shares which are trading at or close to zero, even after years of diligent reinvesting of dividends. Check out FRE,FNM and LEH for reference. With hindsight, investors in those former financial behemoths would have been better off putting their money in US long bonds.

Even if the company doesn’t fail, it could still eliminate its payments to shareholders, which leaves the investor without the dividend income that they were relying onto. GM, which has always been touted as a great barometer for the overall US economy is a recent example of this scenario (remember the saying “As goes GM so does the nation”).

So what should investors do about dividend reinvestment?

I believe that as long as the dividend investor holds a diversified portfolio of income producing instruments, they should be able to weather any industry specific related storms successfully and without losing all of their dividend income in the worst case scenario. The best strategy for this type of person would be to take maximum advantage of the power of compounding and re-invest their dividends.

On the other hand however, if you plan on living off your investments, you might want to hold off dividend re-investment and enjoy your money working for you.

I believe that the question of whether to re-invest your dividends or not is mostly a question of how diversified your portfolio is and when do you plan to use the dividend income that is generated by it.

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This article has 5 comments:

  •  
    Oct 11 08:50 AM
    That's precisely what I have been doing for the past 10 years. I am getting close to looking at retirement (well-maybe I will push it off a little further given how things are).
    Some DRIPS have done better than others, but I still accumulate "extra" shares.........I will sell the "not-so-good-one'... when market turns around and replace them with more "steady dividends & growing payouts" in the coming 2-3 years.
    A good software program can keep track of your re-invested dividends, keep diversified and limit your holdings to a max. of 10% of total investments.
    Reply | Link to Comment
  •  
    Oct 11 11:47 AM
    The only way to compare stocks is to use dividend reinvestment in the calculation of returns.

    BRK does it for you by not paying that dividend to the stockholder.
    Others give you the option by giving the investor the money.
    Reply | Link to Comment
  •  
    Oct 11 11:50 AM
    it was one of the best ways to work towards retirement.with the lack of ethics & transparency,lying ceo's,self serving bod's it will be much riskier in the future.it worked great for me but i would hesitate from here on in.
    Reply | Link to Comment
  •  
    Oct 14 12:15 PM
    Thanks for your article. Needless to say, everyone has to fine-tune their own style of investing. Some favor dividend-paying/reinve... strategies and others do not. There's no hardcore right or wrongs. It's strictly a matter of personal investment preference.

    Personally, I'm a big fan of dividend paying companies and enjoy being rewarded every three months for investing in what I perceive, based upon my own research, to be quality companies such as JNJ, KO, MCD, PEP, KMR, and the like.
    Reply | Link to Comment
  •  
    Oct 17 11:10 PM
    High dividend stocks usually perform the best in recessions. Research shows they recovered 8 years faster than low dividend stocks.

    investmentscientist.co.../
    Reply | Link to Comment
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