Inside: It can be hard to imagine how you can save enough to retire in comfort and have enough for travel and fun. Discover another tool you can use to boost your savings.
Are you struggling to figure out how your investments can grow large enough for you to retire, be independent, help your kids (or grandkids) with school, and even take great vacations?
In order to retire comfortably, you’ll likely need to invest in the stock market rather than just putting money into a CD or savings account. But did you know that you can give those investments an even larger boost through dividend reinvestment plans?
Wait, a what? Let me back up a step.
What are dividends?
Dividends are a portion of earnings that a company chooses to share, or distribute, to its shareholders. Basically, you can think of dividends as a “thank you for investing with us” gift. It is also an incentive for shareholders to stick with the company and a way to attract new investors.
Not all companies offer dividends, and not all should. Younger and high-growth companies usually won’t offer dividends because they want to use the money to help the company grow quickly or expand. Companies that do offer dividends are often older and well established.
Companies normally pay out dividends on a regular basis. It could be monthly or yearly, but quarterly is the most commonly seen time period. The board of directors for a company decides on how much the dividend will be and whether to even pay one. You will want to check a company’s payout history and look for one with a consistent and steady record of dividend payments.
What is dividend reinvestment?
Now that you know what a dividend is, what about dividend reinvestment? Dividend reinvestment is reinvesting the dividend you receive right back into the company. When you do this, you will see something called a dividend payment on your statement, but then that payment is automatically used to buy more shares of the stock. This is called a dividend reinvestment plan, or DRIP.
Why DRIP is awesome
Reinvesting dividends is as great as compound interest. In fact, it can help your money grow even faster.
How much faster can your investments grow? Let’s look at a 20-year investment in Sherwin-Williams (SHW). Suppose you were able to purchase $10,000 of stock in SHW on Jan 2, 1996. If you took dividends as cash, your investment would have grown to almost $144,874. That is great!
But wait! If you had elected to reinvest those dividends, you would have ended 2016 with over $192,254. That is over $47,000 more simply from reinvesting dividends. You can check this dividend calculator for yourself.
That is the power of reinvesting. You use the dividend to buy more shares. Then when the next dividend is paid out, you get a slightly bigger piece of the pie because you have more shares. Lather, rinse, repeat.
Of course, investment returns vary and not all will do as well as the corner paint store.
Reasons to enroll in a DRIP
There are several reasons why you should opt for dividend reinvestment versus taking cash from dividends:
Compounding returns over time
The dividends are automatically used to buy more shares which give you more shares to get dividends from in the future. Your piece of the pie gets bigger and bigger with each payout.
No market timing
Because shares are automatically purchased with the dividend, you will be dollar cost averaging your purchases. You won’t be trying to time the market (which is a losing proposition).
If you were to take the dividends as cash and then buy the shares, your brokerage would likely charge a commission for the transaction. When you buy shares through dividend reinvestment, there isn’t a brokerage fee.
When you buy shares through a DRIP, you will get however many shares that dividend can buy, even if they are a fraction of a share. So, you could get 23 shares or 2.715 shares. If you were to try and buy shares with cash, you would need to purchase whole shares, either leaving you with leftover cash or not enough money to buy a full share.
Portfolio growth in down markets
When markets are down, reinvesting dividends can help your portfolio grow by buying more shares of the stock or fund while prices are low.
When DRIP may not be right for you
As wonderful as dividend reinvesting sounds, there are times when it isn’t the best option.
Investments in taxable accounts
If your investments are in a taxable account, then reinvested or not, dividends are taxable. If you reinvest your dividends, you will need to cover the taxes somehow. Also, if you want to avoid being double-taxed on your dividends you will need to keep good records of each purchase.
May need the cash
If your investments are not in a retirement account but are in a taxable brokerage account, then you could use cash dividend payouts to pay down debt. If you are retired, you may want to keep your investments and use the dividend income for living expenses.
When you reinvest dividends, you are always purchasing more of the same investment. If you opt to have your dividends deposited to a money market account with the brokerage, you could use the money to diversify and buy shares of another stock.
No control over purchase price
There may come a time when you feel the investment is overpriced or no longer a good buy and would rather not reinvest in the stock. In this case, it is better to discontinue reinvesting dividends in that stock.
Lost faith in the company or fund
Sometimes, a company may falter and even fail. If you are feeling particularly skittish about an investment, it is probably better to take your money and move it to another investment.
How do I reinvest dividends?
If you see dividend income on your statements, but it isn’t going to a cash account, then you are likely set up with dividend reinvestment. Otherwise, if the dividends are deposited to a cash or money market account that is earning next to nothing in interest, your investment is not set up for dividend reinvestment.
Your brokerage often has a place where you can decide how you want to receive your dividends and elect reinvestment. If you know you are getting dividends that are not being reinvested and have trouble finding the option, give your brokerage a call for assistance.
If you don’t want to research and invest in individual stocks, many mutual funds pay out a dividend as well. Check the funds you have invested within your retirement accounts to see if they are paying dividends that could be reinvested as well. This is a great way to amplify your returns and help boost those retirement savings. This, in fact, is what we do.
Giving your portfolio this boost over the long term can really help you meet your savings goals for a more enjoyable retirement.
Do you reinvest dividends? How have the returns helped you?