If you’re asking me, “should dividends be reinvested?” then I am telling you that the answer is always a resounding YES!
Now, if you’re asking me if those dividends should be reinvested back into the same stock that earned those dividends, that is a much different question! But don’t worry, I’m here to help cut through some of the nonsense and get you an answer that will help you properly invest your dividend income!
Have you ever heard that “time in the market beats timing the market?” Well, it’s 100% true, and the numbers show it. Statistically speaking, when you have money that you want to invest, you should try to get that money into the market as fast as you can!
I’m telling you right now that you should NEVER dollar cost average if you’re seeking maximum returns. I know that might seem like a hot take but it’s true.
I mean, think about it – the stock market has historically gone up over time, on a fairly reliable business, so wouldn’t it make sense to put your money in as fast as you can?
Of course, sometimes it will backfire, but the odds say that if you were to put your money in today then it’ll be at a lower price than what it would be if you invested tomorrow.
When comparing lump sum investing vs. dollar cost averaging you can see that it’s a no brainer that you should get your money into the market as soon as you possibly can, and the same remains true for dividends.
So, as soon as you get those dividend payments, put those funds back into the market so you can continue to capitalize on compound interest!
Is the DRIP Program Still Relevant?
Now, chances are that you are asking this question because you have heard about DRIP, or Dividend Reinvestment Plan, and you’re wondering if this is applicable to you. Well, to be totally honest, I don’t know if DRIP really is that applicable anymore…
DRIP essentially is that when you earn a dividend, that money then is automatically invested right back into that same company that paid you the dividend in the first place. So, let’s imagine this scenario:
You’re invested in one of the greatest dividend kings of all time in 3M (MMM) and you own 10 shares of that company. On 5/21/20, MMM paid its quarterly dividend of $1.47/share, and since you own 10 shares, you received a total payment of $14.70.
You can either receive this as just cash in your account or you can enroll in DRIP, meaning that you will instantly get more shares of MMM for the equivalent of that dividend payment. Let me help explain below:
As you can see, that $14.70 in dividend payments is enough to get you .1008, or just over 10% of 1 more share. You now own 10.1008 shares instead of the original 10, meaning that the total value of your stock is at $1,472.80, or $14.70 over the amount of your initial investment (which is the same as the dividend that you received).
The beauty is that you could just keep this going, quarter after quarter, because 3M has one of the most sustainable track records of growing their dividend over time that you don’t have a lot to be worried about with them cutting their dividend, but is this actually the best strategy for you?
DRIP really provided (note that this is past tense) three main benefits to the common investor:
- You don’t pay commission on that transaction
This is a huge advantage! Or, maybe I should say that it USED TO BE a huge advantage. You see, commission on a transaction of stock used to be $5+ every single time that you bought and sold stock.
So, if you weren’t enrolled in DRIP and you wanted to invest your $14.70 into MMM, you were going to pay a $5 fee. That’s effectively a 34% fee right off the bat since you’re investing such a little amount.
By being able to avoid this fee, you had a huge leg up to keep your money in the market and let it keep on compounding.
But times have changed – about a year ago many brokerage firms decided that they were going to drop ALL commissions on transactions, both on shares being bought and sold. This didn’t include all brokerage firms, but it did include many of them such as Fidelity, Ally, E-Trade, TD Ameritrade, and many others!
I think a lot of this can be attributed to Robinhood gaining traction with the younger investor as they pioneered free trades, but now that almost all brokerages offer it, you might be wise to switch your brokerage firm to a more credible source (that won’t crash in the middle of a market downturn as Robinhood likes to do).
As long as you’re invested with one of these brokerage firms that offers free trades, then 1/3 of the major benefits of DRIP are gone. But let’s just pretend that you’re invested with a brokerage firm that doesn’t offer free trades, and for whatever reason you can’t switch to a new brokerage (I have no idea what this would be), at least you can reap the rewards of this next major advantage, right?
- You can buy partial shares
Just as with the example that I provided above, when you’re opted into DRIP, you have the ability to buy partial shares! This can used to be a huge advantage to any investor that is trying to keep as much of their money invested in the market.
Using the same example above, you wouldn’t have been able to buy another share of MMM because you didn’t have enough from your dividend payment to do so. You’d either have to get more cash by selling a different stock or putting more money into your account, or just let your money sit there and do nothing.
Pretty big advantage, right?
Well…it used to be.
Now, many brokerage firms will offer partial shares for just any joe blow on the street. You don’t have to be partaking in DRIP…you don’t have to do anything special at all…you just have to be part of a select few brokerages (but I have a really strong feeling that many more brokerage firms are going to be offering this very soon.
For instance, I invest with Fidelity and I know that they offer partial shares as long as you buy on their mobile platform. I personally do not do this because I try to keep a “speed bump” as Dave coined it, to keep me from making an impulse decision and buying or selling on my phone, but if I really, really wanted to buy partial shares, then I absolutely could do that.
When I was first starting investing, this was a major benefit and a huge reason that I chose to DRIP my investments. It allowed me to keep 100% of my money invested 100% of the time, but now, that advantage is essentially gone as long as you’re invested in one of these brokerage firms that offer the ability to buy partial shares.
So, now we’re down to only 1 of the three major benefits of DRIP being left…. but is it still left?
- Your money is instantly invested and it takes no action on behalf of the investor
This is another fantastic thing that DRIP provides for you and it gives you the ability to miss 0 seconds of time in the market which obviously is a win win, but there might be a little “hiccup” along the way… potentially.
What happens if that stock made a huge run and now it’s overvalued? You could theoretically view this as a way of just continuing to gain more exposure to the stock, or if the stock took a big hit then you’re just lowering your average cost of ownership of the stock, but at the end of the day – you’re really buying shares of a company without actually knowing what price you’re buying at.
While I loved this as a newer investor because it kept me from getting overwhelmed at the frequency that I needed to make a decision to buy stock, the more comfortable that I get in my investing journey, the less that I felt like this was a benefit.
Opportunity Cost on Reinvesting Dividends
I recently talked about how I just started to take control of investing in my 401k vs. having Fidelity manage it because I’ve gained confidence throughout my investing career, and that confidence is also the same confidence that has made me think that automatically putting dividends into a company without me actually doing it.
We’re living in a super volatile world with all of the COVID-19 volatility going on, right? I mean, the stock market is volatile enough as is, but this is just some next-level types of volatility. If I have two stocks that both gave me a dividend, and one has drastically increased in price and the other has drastically decreased, but the actual business hasn’t changed and I still really trust both companies, then wouldn’t I want to buy more of the company that has dropped in price?
Of course! I will get more bang for my buck.
If I was opted into DRIP then I would never even have this opportunity. The dividends would be automatically invested before I even had the choice to make the decision.
For me, this is not ideal, but if you’re wanting to be hands-off and not have to login to your brokerage every few months (at least), then maybe DRIP is for you!
Personally, I love getting into the numbers and evaluating stocks. Like, I legit love it. It’s not something that everyone loves and I get that, but I thoroughly enjoy evaluating my investments and making sure that I am investing in a stock with the most growth potential and the biggest discount to its intrinsic value.
That might sound overwhelming, and if it is, I totally understand, but just take it in baby steps. Start with some introductory valuation ratios and take a look at the Value Trap Indicator, which I think is the best way to find a company that is undervalued vs. their intrinsic value (aka a great buying opportunity).
In summary, I still want to say that I think DRIP is a great tool. There are some brokerage firms that do not offer free trades, and there are some brokerage firms that do not offer partial shares, and there are some investors that love certain companies and want to pick that stock and forget it, and that’s completely fine!
If you’re the type of person that likes to do your own analysis and run the numbers on your own, then maybe DRIP isn’t the best bet for you, but I know that there are a lot of people that will prefer to automate things if they can.
If you’re someone that’s enrolled in DRIP solely because you have a brokerage firm that doesn’t offer free trades or partial shares, then my biggest piece of advice is to find a new brokerage firms. Sure, DRIP might work for you on dividends, but what about when you put $100 in and the share price is literally anything except $100? Or, what about when you put $100 in each week and you’re paying $5 right off the bat.
$5 might not seem like a ton of money, if you invested that entire $100, every week for 30 years, you would have $636K at the end:
If you had to pay $5 each time then you’d only have $604K at the end of the 30 years:
When you’re talking about hundreds of thousands of dollars, $32K might not seem like a jaw dropping amount, but you’re doing LITERALLY NOTHING different…you’re just using a better broker that doesn’t charge you fees!
So, at the end of the day, should dividends be reinvested? YES! But only in the way that makes the most sense for you!