Take your dividends or reinvest them?
When you invest you are faced with the choice of taking any dividends you may receive as cash or reinvesting it. This decision should only be made when you understand the rationale behind each approach and which complements your investment strategy best.
Many investment trusts and companies offer regular payments to shareholders, known as dividends, which may amount to an attractive pot of money depending on the size of your investment and the amount the company will pay per share. The dividends can be used as a form of income or it can be reinvested in the company.
Whether you choose to take your dividends as income or reinvest it comes down to your personal goals and whether you want to increase your stake in the company. To inform your decision it is helpful to understand the reasons why many investors choose to take the money and why many choose to reinvest it.
First and foremost, dividend payments are never guaranteed, so it is worth looking at the dividend history of the trust, fund or company you are considering to gauge what kind of dividends you can reasonably expect and how often you can expect it. For example, many investment trusts aim to deliver above-average and growing dividends every three months, while others are less concerned with growing dividends and more focused on growing the value of your investment – and some try to do both.
For investors with a substantially large pot of money to invest, the value of their potential dividends might seem rather attractive as a form of regular income. There are investors for whom the dividends from their investments can cover their living expenses, for example. In this case, it is understandable why someone might choose to take their dividends as income.
For investors with a smaller pot of money, the potential dividends earned on their investments might not be enough to cover their living expenses – but that’s not to say it can’t be a welcome stream of income. It might cover a few subscriptions or pay a few household bills, for example.
As for reinvesting dividends, many investors choose this as a way of topping up their investments. Instead of getting paid dividends as cash, some investors use it to buy more shares in the investments they hold. That leads to a snowball effect because dividends are paid on each share you own; the more shares you own the more dividends you can expect; and the more dividends you get the more shares you can buy, and so on. As mentioned earlier, there is no guarantee that dividends will be paid, so the number of shares you own may not always increase and the value of your investment may fall as well as rise.
Should you choose to reinvest your dividends, it can be done automatically through most share dealing services, but they typically charge you for this function so it is well worth checking out their rates beforehand. The cost of reinvesting automatically might reduce the amount of shares you can buy with the dividends significantly. If the cost of reinvesting is too high relative to the total dividends, there are alternative approaches if reinvesting is definitely your preferred option. For example, rather than automatically reinvesting dividends as they are paid, you could investigate the possibilities of amassing a dividend fund and reinvesting with a lump sum.
Reinvesting dividends in a company that is doing well is a popular strategy for many investors. But a company performing well today might not be so successful in the future, so it is wise to monitor your investments and track their performance. You might decide that you no longer want to reinvest if you don’t like the company’s prospects. At the same time, stock markets can be volatile over a short-term period and some companies might be undervalued. In this situation, buying more shares at a cheaper price might be very attractive if you think the company’s share price will bounce back – a bit like bargain hunting.
Whether you choose to receive dividends as an income or reinvest it, the decision is entirely yours and there is no right or wrong answer. Reinvesting automatically should not be seen as a simple way to grow your investment – it requires attention to detail and confidence in your choice of investment fund; and relying on dividends as a form of income is not without risk – imagine a company cuts its dividends, leaving you with a much smaller pay packet. Understanding these risks should help you make the choice that is right for you.