What is Reinvestment
Reinvestment is using dividends, interest and any other form of distribution earned in an investment to purchase additional shares or units, rather than receiving the distributions in cash.
BREAKING DOWN Reinvestment
Reinvestment is a great way to significantly increase the value of a stock, mutual fund or exchange-traded fund (ETF). It is facilitated when an investor uses proceeds distributed from the ownership of an investment to buy more shares or units of the same investment. Proceeds can include any distribution paid out from the investment including dividends, interest or any other form of distribution associated with the investment’s ownership. If not reinvested these funds would be paid to the investor as cash.
Dividend reinvestment plans, also known as DRIPs, allow investors the opportunity to efficiently reinvest proceeds in additional shares of the investment. Issuers of an investment can structure their investment offerings to include dividend reinvestment programs. Corporations commonly offer dividend reinvestment plans. Other types of companies with public offerings such as master limited partnerships and real estate investment trusts can also institute dividend reinvestment plans. Fund companies paying distributions also decide whether or not they will allow dividend reinvestment.
Investors investing in an investment that is traded on a public exchange will typically enter into a dividend reinvestment plan through their brokerage platform elections. When buying an investment through a brokerage platform, an investor has the option to reinvest dividends if dividend reinvestment is enabled for the investment. If dividend reinvestment is offered, an investor can typically change their election with their brokerage firm any time during the duration of their investment. Reinvestment is typically offered with no commission and allows the investors to buy fractional shares of a security with the distributed proceeds.
If an investor is reinvesting proceeds they may need to consider reinvestment risk. Reinvestment risk can arise across all types of investments. Generally, reinvestment risk is the risk that an investor could be earning greater return by investing proceeds in a higher returning investment. This is commonly considered with fixed income security reinvestment since these investments have consistently stated rates of return that vary with new issuances and market rate changes. Prior to a significant investment distribution, investors should consider their current allocations and broad market investment options.
Reinvestment is an important consideration for all types of investments and can specifically add to investment gains for income investors. Numerous income focused investments are offered for both debt and equity investments. The Vanguard High Dividend Yield Fund (VHDYX) is one of the broad market’s top dividend mutual funds. It is an index fund that seeks to track the FTSE High Dividend Yield Index. It offers investors the opportunity to reinvest all dividends in fractional shares of the Fund.
Income investors choosing reinvestment should be sure to consider taxes when reinvesting paid distributions. Investors are still required to pay taxes on distributions regardless of whether or not they are reinvested.