Should I Reinvest Dividends or Take the Cash?

If your investments pay dividends, you may be wondering whether you should take them as cash or reinvest them, which will give you more shares over time. 

The answer depends in part on your investment goals. Some investors use dividends as a source of income to cover everyday expenses, while others focus on increasing their savings. For those who are focused on longer-term growth, reinvesting dividends can be a way to try to increase returns.

How to reinvest dividends

Dividend reinvesting can be done automatically or on your own. Here are two ways you can reinvest your dividends:

• DRIP investing. Some companies offer direct dividend reinvestment (where you buy your shares directly from the company rather than on an exchange). Instead of receiving dividends in cash, you receive additional shares. Such a program is called a dividend reinvestment plan, or DRIP. Some DRIPs allow additional (often fractional) shares to accumulate commission free and will even issue partial shares. However, not all companies offer DRIPs. 
• Reinvest on your own. Instead of receiving your dividends by check, you could have them automatically deposited into your account. Then, when you have enough money to buy additional shares, you can purchase them on the open market. Buying on your own can increase your universe of investment choices, but making multiple small share purchases can mean higher transaction costs over time.

How does compound interest work?

When deciding whether to reinvest your dividends or take them as cash, consider what compound interest can do. For example, take a $10,000 investment in a stock with a 3% annual dividend and apply some simple math (see figure 1). The first year that investment could’ve risen to $10,300. If the company pays the same 3% annual dividend the next year, it could grow to $10,609. Repeat in year three, and the investment would be $10,927. Repeat for 10, 20, or 30 years, and compounding can dramatically enhance potential returns. 

But this scenario doesn’t consider the value of the stock itself. If the stock price appreciates at the same time, say 5% annually, the total return would be 8%. By year three of our example, that 8% return on the stock would’ve grown the total investment to $12,597 and change. Of course, the stock can go down in value.

But remember, this is a simplistic look. Dividends and dividend rates fluctuate, as do stock prices. Past performance is not a barometer for future results. The stock market doesn’t climb in one neat trajectory; it zigs and zags, sometimes dramatically. And companies cannot guarantee their dividend payouts. Profits rise and fall, business cycles happen, and the economy can be bumpy. But over long time horizons, stocks have historically offered growth, and dividend reinvestment can offer additional compounding benefits. Still, it’s important to know that stocks can decline and even go out of business, and stock markets can be turbulent and even turn into sustained bear markets. 

Should I always reinvest dividends?

It depends on your goals and financial needs. There is no right or wrong answer here because the correct response is what best fits your own personal situation. 

You can use a dividend reinvestment strategy to attempt to grow your portfolio and accumulate more for retirement. On the other hand, if you need to meet short-term goals or cover everyday expenses, you might want to take your dividends as cash.

Taking the income in those situations might make sense. You’re still maintaining a position in the stock, while keeping the same amount of shares within the company and benefiting from potential capital appreciation.

No matter what your approach to dividends is, whether you choose to reinvest or take the dividends as cash, keep a close eye on the stock. Monitor the stock’s price regularly and stay informed of any changes to dividend payments so you can make sure your strategy is working in your best interest.