Reinvesting Dividends 101

Q

What is Dividend Reinvestment?
This is a little different that DRIP, which I mention below.
When you sign up for an account, you generally decide what you are going to do with your dividends. You can either take them as cash (which gets deposited to your sweep account) or you can automatically buy more shares of the fund with the dividends.
Folks like dividend reinvestment because it is cheap, easy, automatic, and allows you to buy fractional shares through dollar cost averaging resulting in compounding growth.

What is DRIP?
DRIPs are dividend reinvestment plans which are offered by individual companies on their stocks. Mutual funds, ETFs and low-cost brokerages don’t have DRIPs, they have automatic dividend reinvesting which can be turned on or off.

Reasons for Dividend Reinvestment
Of all the reasons to automatically re-invest dividends in equity holdings, automatic is the key. You can take better advantage compound growth when you reinvest dividends back into purchasing more shares.
In addition, there is less cash drag. Instead of spending time in the sweep account earning less than zero point nothing percent, your money can compound and earn dividends on the dividends!

Reasons not to Reinvest
There are a few reasons you might want to stop auto reinvesting.
One is control. If you are attempting to adjust your Asset Allocation, manually re-invest the dividends in the sweep account.
In addition, if you are tax loss harvesting, you need to worry about wash sale rules. If you sell something in your taxable (brokerage account) to harvest the loss, you shouldn’t be buying back shares (in any account) for 31 days.
Some say it is easier to take distributions directly from the sweep account rather than having to sell shares to liquidate money. That is, if you are living off your investments, you might as well have cash waiting for you rather than having to sell off shares.

Should I Reinvest Dividends?
If you want to know if you should or should not reinvest dividends, we need to know a little more about the account type you are dealing with.
Account Type and Dividend Reinvestment

Retirement Accounts
Since there are no tax liabilities associated with buying, selling, capital gains or dividends in retirement accounts, it is optimal to automatically reinvest dividends in these pre-tax retirement accounts. Lack of cash drag is one of the biggest advantage; you are always fully invested. Learn more about your 401k, 403b, 401a, and 457 retirement accounts where you should usually continue to reinvest dividends.

Brokerage/Taxable Accounts
In taxable accounts, debate about reinvesting dividends is common.
If you are a low-maintenance, hands off, or an infrequent investor, automatic dividends are likely best.
If you are contributing monthly to different taxable investments, or want to do tax loss harvesting, than turn off the automatic dividend reinvestment.
When to Stop Automatic Dividend Reinvestment
When you are 5-10 years from retirement, you should stop automatic dividend reinvestment.
This is when you need to be moving from you accumulation asset allocation to your de-risked asset allocation.
Between 5 and 10 years before retirement, you are transitioning from 70/30 (or 100/0) down to 50/50.
50/50 or whatever your asset allocation is at the peak of Sequence of Return Risk. Consider a Bond Tent!
In order to make this transition, stop automatic dividend re-investing and every 6-12 months, re-invest as per your new asset allocation. Go Conservative!
This might give you larger lots if you are using specific identification of shares that let you be efficient when you are harvesting capital gains during early distributions.
It can also simplify your tax reporting when you are taking income out of your brokerage account to live on. If you need the money to spend, just spend it! Stop reinvesting dividends.
Accumulation vs Drawdown (vs Transition)
In Summary: When in accumulation, reinvest dividends.
When in transition or drawdown, don’t! Especially in your brokerage account!
One final point. Always remember that money is fungible!
Money is Fungible, or, Do You Need Dividend Reinvesting?
Remember, money is fungible, so it really is all the same. It doesn’t care where it came from, where it is going, or what account it is in. Money is Money!
Do what is easiest for you and what makes sense! In the end, there is no real advantage on way or the other way, since money is fungible.
If this is just more than you want to know, then just reinvest dividends and don’t worry about it.
Should I reinvest dividends is only an issues because you are given a choice whether to do it or not, rather than a choice that really makes all that big of a difference.

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2022-01-05, 219👍, 0💬