FMD Capital Management

Should You Reinvest Your Dividends?

Written by David Fabian, March 16th, 2013

I often get asked this question from clients who are curious about whether it is a better strategy to reinvest your dividends back into the securities that distributed them or have them pay to cash?  The answer really depends on what your needs are and what your long-term strategy is for the investments that are providing this income.  My personal preference (and what I do with my own accounts) is to have the dividends reinvest.  This accomplishes two simultaneous goals:

1.  You are able to increase your total portfolio allocation to the fund that is paying the dividends and thus increase the amount of future dividend payments.

2.  You are continuing to compound your total return in the original investment by acquiring more shares that may rise over time.

However, this strategy is not always the best option for everyone.  If you are retired and living off of the dividend distributions from your investments it may make more sense to have them pay to cash in your portfolio and on a monthly or quarterly basis to have the proceeds swept into your checking account.  This gives you the liquidity and flexibility to put the cash to work for your every day expenses or look for other investment opportunities with the additional funds.  In addition, if you are planning on only owning an investment for a short period of time, it may make better sense to have any dividend proceeds deposited as cash so that you don’t have to worry about additional settlement times or fractional shares.

iStock_000003569447SmallEither way with today’s brokerage accounts you have the ultimate flexibility with your dividend payments.  Many brokerage accounts let you select what option you prefer when you setup the account (either reinvest all dividends or pay to cash).  In addition, if you select “pay to cash” at the account level, they even give you the ability to have specific investments reinvest at your discretion.

Many people are aware that mutual funds pay dividends and you are able to reinvest these proceeds back into the fund by opting to purchase additional fractional shares in leu of cash, but did you know that you can do the same thing with many ETFs as well?  It is a little-known fact that many brokers will allow you to own fractional shares of many ETFs.  When a dividend is declared, your broker will do the math and acquire fractional shares for you on the day that the fund company pays these proceeds.  This allows you the benefits of reinvesting that was previously only available for mutual funds and DRIP stock plans.

The decision for how to handle dividends is one that is unique to each client relationship and investment.

If you are interested in learning more about our four-sleeve approach to income investing, I encourage you to download our special report on The Strategic Approach To Income Investing.