The dividend dilemma: Reinvesting vs taking cash
One of the perks of owning shares is being paid dividends. Most companies pay dividends twice a year, after announcing their full-year or half-year results.
An important decision that needs to be made is how you'd like the dividends paid - do you want to reinvest them to get additional shares in the company or do you prefer to get them as cash?
This list of pros and cons may help you work out which option is best for you.
The pros of reinvesting dividends
You benefit from compound interest
Reinvesting your dividends taps into the power of compound interest. When you reinvest any earnings, like dividends or interest, your original investment plus those extra gains work together to boost your returns even more.
When you use dividends to buy more shares, it will also increase the dividends you receive the following year. Over a long period, compound interest has the potential to see income increase significantly.
It's automated
Dividend reinvesting provides an automated investment - there is nothing that you have to do to build your portfolio every time income is paid.
There are cost advantages
There are no brokerage fees associated with the shares issued as part of a dividend reinvestment plan, although it is worth noting that we live in a time when brokerage has never been cheaper, reducing this advantage somewhat. As well as not having to pay brokerage, the shares may be issued at a small discount, providing a second cost advantage.
The cons of reinvesting dividends
Record-keeping can be complex
Historically, the record-keeping for dividend reinvesting has been challenging for investors. For example, if you own a holding for 15 years and receive two dividends a year, that creates 30 purchases that you have to keep track of to calculate capital gains when you sell. This disadvantage has been somewhat offset by improved record-keeping options for portfolios, but it remains a factor to be aware of.
You could be 'wasting' some of the money
Another challenge is that money that does not buy a 'whole' share is held over to the next dividend period rather than being put to work somewhere in your portfolio. For example, a $50 dividend in a company with a share price of $20 would see two shares purchased, and $10 'left over' until the next dividend period. This is not a big deal for a company with a share price of around $4 like Telstra, however, an investor using a dividend reinvestment plan with Rio Tinto, with a share price of around $120, might see larger sums of money waiting for the next dividend period before being put to work in the market.
There's a lack of strategic allocation of funds
When you choose to reinvest dividends, you are essentially saying that the company you are reinvesting in is the optimal investment that you can make at that time. If you reinvest dividends in Telstra, for example, you are saying that from an asset allocation, share selection and personal finance strategy perspective Telstra shares are the best decision to make at the time when the dividend is paid.
If, rather than using the dividend reinvestment plan you received the cash, you would be in a position to decide which asset class, which underlying investment, when and how (i.e. through your superannuation, in your own name, or even a non-investment strategy such as making an additional mortgage repayment) you use the dividend.
You don't get to enjoy any of the cash
Receiving dividends is a great benefit of investing and I think there is value in enjoying at least some of the benefits of receiving cash dividends. Receiving a cash dividend from an investment and spending part, perhaps even a small part, of that cash on something that can be enjoyed (even as small as a favourite snack, something to read or a couple of movie tickets), is a tangible reminder of the benefits of investing, and a reward for making the effort to save and invest.
Key takeaways
'To reinvest or not to reinvest' is a topic that doesn't seem to have a definitive answer. Perhaps early on in a person's investment experience the automation, simplicity and cost-free access to compounding might put dividend reinvesting plans a little ahead of cash dividends. As portfolios grow and mature, the ability to use a cash dividend to make strategic decisions might put cash ahead. Either way, thinking about which approach best suits your situation makes sense.
Frequently Asked Questions about this Article…
Reinvesting dividends allows you to benefit from compound interest, as your original investment and additional gains work together to boost returns. It also automates your investment process and can offer cost advantages, such as no brokerage fees and potential discounts on shares.
The drawbacks include complex record-keeping, as you need to track multiple purchases over time. Additionally, you might 'waste' some money if it doesn't buy a whole share, and there's a lack of strategic allocation since you're automatically reinvesting in the same company.
Compound interest benefits dividend reinvestment by allowing your original investment and reinvested dividends to generate additional returns over time, significantly increasing your income in the long run.
Yes, reinvesting dividends can offer cost advantages such as no brokerage fees and the possibility of purchasing shares at a discount, making it a cost-effective way to grow your investment.
Record-keeping can be challenging because you need to track each dividend reinvestment as a separate purchase, which can become complex over time, especially if you hold shares for many years.
The strategic disadvantage is that reinvesting dividends assumes the company is the best investment choice at that time, limiting your ability to allocate funds to other asset classes or investment opportunities.
Receiving cash dividends allows you to enjoy the tangible benefits of your investment, such as spending on personal rewards, and provides flexibility to allocate funds strategically across different investments or financial goals.
Investors should consider their investment goals, portfolio maturity, and personal financial strategy. Early on, reinvesting might be beneficial for automation and compounding, while mature portfolios might benefit from the strategic flexibility of cash dividends.