Many financial experts recommend that you reinvest dividends most of the time – and I’m inclined to agree. The process is typically automated, doesn’t incur any fees and gives your holdings a little (or a lot) of extra oomph.
For example, if you had invested in Microsoft stock 10 years ago and consistently reinvested your dividends since then, your holdings would be worth 63% more today than if you hadn’t reinvested. That’s a lot of oomph.
Still, there is hardly ever a one-size-fits-all answer to any investment question. Accordingly, it may be wiser in some situations to just take the money rather than reinvest it.
Here’s what investors should know about when it makes sense not to reinvest dividends.
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3 Good Reasons to Not Reinvest Dividends
Here are three common examples of situations in which it makes sense to not reinvest dividends:
- Balancing your portfolio. Reinvesting dividends will increase your position in the company paying them. If that company already represents, say, 5% or more of your portfolio, it may be wise to avoid getting too concentrated and not reinvest your dividends.
- Phasing out risk. In many cases, it’s a good idea to make your investments less aggressive over the years. If you’ve been reinvesting dividends, diverting that cash toward less aggressive assets (like bonds) can be a good way to “risk-off” smoothly.
- Income. Remember: Money is ultimately for spending, and sometimes you just need the cash. There’s nothing wrong with that, especially if you’re in or approaching retirement when short-term income becomes a bigger priority than long-term growth.
1 Bad Reason to Not Reinvest Dividends
Remember, one of the main benefits of dividends is that they pay out regardless of the stock’s recent price movement. This indicates that the company paying them has an established track record of earning profits – a clear sign that the company is fundamentally worth investing in.
In other words, even if the share price is in a slump, odds are it will recover eventually. So if you’re going to hold onto the stock anyway, and therefore keep receiving dividends, why not keep getting the extra boost from reinvesting them?
As I like to remind my clients, we invest in companies, not stocks. The share price is only one indication of a company’s value, and sometimes a very unreliable one. That truth is often forgotten and always important.
What to Do Next
If you’re receiving dividends and are unsure of what to do with them, remember the fundamentals.
Deciding what to do with your dividends boils down to answering three questions:
- Am I confident in the company’s underlying health?
- Can I afford to reinvest the dividend income right now?
- Is increasing my position in this company consistent with my overall portfolio strategy?
If the answer to any of these questions is “no” or “I’m not sure” then you may want to spend that dividend cash elsewhere.
If you can answer all of them with “yes,” however, then let the reinvestment machine keep doing its thing.
Investing and Retirement Planning Tips
- If you have questions specific to your investing and retirement situation, a financial advisor can help. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- For more about dividend investing check out this article on the subject.
- As you plan for income in retirement, keep an eye on Social Security. Use SmartAsset’s Social Security calculator to get an idea of what your benefits could look like in retirement.
Graham Miller, CFP® is a SmartAsset financial planning columnist and answers reader questions on personal finance topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Graham is not a participant in the SmartAdvisor Match platform.
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