Should I reinvest my dividends or save them?
Do I reinvest my dividends or hold on to them and save in case of a market dip?
Reinvest, reinvest, reinvest!! Albert Einstein is usually credited with saying that compound interest is the eighth wonder of the world. By reinvesting your dividends, you take advantage of compounding interest. Don't argue with Albert.
Reinvesting dividends is really dependent on a range of factors including your age, risk tolerance, current and target portfolio allocation. Based on your question, I assume that you are not using dividends to supplement your income.
I typically recommend using the extra cash from dividends as a tool to rebalance your investment portfolio back to your target asset allocation. Basically, you can buy assets that have recently underperformed. On the other hand, if you reinvest the dividends in asset classes that have higher than the target allocation, you can increase the risk of your portfolio. Also, trying to time the market can be a bad idea. As we have seen many times, markets can be very unpredictable. Sticking to your long-term goals and target allocation is a better strategy during volatile markets.
If you’re a long term investor, reinvestment of dividends is way to accumulate more shares over time. This is where the power of compounding comes from. Your dividend is reinvested into more shares. The increased number of shares now generate a higher dividend amount. And so on. Think of it the same way as compound interest. I wrote about that in more detail in the article Compound Interest – Make It Work For You.
An example of when it might be better to take dividends as cash is when one is relying dividends for current income. If you need income, dividends can help provide that.
There is a problem with taking dividends as cash to be used “in case of a market dip.” 1) What if the dip doesn’t come as soon as you’ve expected? That cash could have been reinvested to increase future dividends. 2) You would have to time the market, which isn’t advisable for long term investors.
Please note that this should not be considered investment advice and is only educational in nature. Be sure to consult your own investment, tax, or legal professional for help with your specific situation.
Best of luck!
David N. Waldrop, CFP®
The answer to this depends heavily on your current situation.
If your strategy is to use the dividends to buy stocks when the market dips (so you can buy low), I think this is a great decision. Just make sure you have a plan such as investing when the market drops 10% or 20% and stick to your decision. Inevitably, when the market starts dropping, people get scared and may abandon their plan. Whatever your plan is, stick to it and don't try and wait for a market bottom. Set your parameters and stick to them.
If you're thinking about holding on to the dividends to save up a cash account, that could also be a good decision. You could use those dividends to build up an emergency savings account you hold in cash and only use when needed (loss of a job, decrease in income, etc.).
If overall, you like the stocks you own and plan on holding them for the long haul, there is nothing wrong with automatically investing the dividends.
Reinvesting dividends is a good way to keep capital deployed without incurring additional costs (as long as we're not talking about a mutual fund with a sales charge, in which case, we need to have a broader conversation). I typically like to reinvest dividends because it provides a sort of dollar cost averaging approach and it lessens the "cash drag" on a portfolio.
With the above said, if you feel that you're becoming overly concentrated in a given stock, then it may be wise to use the dividend proceeds to build some added diversification to manage risk in your portfolio.
There is no single solution for investors, so please take this as purely informational and be sure to visit with your advisor or myself before making any changes to your plan.
Adam C. Harding, CFP