It’s time for another review. Most brokers will offer a Dividend Reinvestment Plan (DRIP) for stocks, mutual funds, and ETFs that regularly distribute dividends. Investors also have the option to opt out of this feature and invest the funds elsewhere. Is it more advantageous for investors to reinvest the dividends or to move on with another investment? We will take a look at this more in-depth below.
First, what are dividends? Some public companies or funds will reward their investors with cash distributions.
Often every quarter. Most companies that pay dividends are value stocks or have been established in the market for a long time.
A growth stock will very rarely pay its shareholders. These will decide to reinvest their profits back into the business. Some funds invest in certain sectors that distribute dividends as well. Below are a few examples.
The energy sector includes oil, gas, materials, metals, chemicals, and other products. Companies in this sector often pay a higher-than-average dividend yield than their competitors.
However, the price of commodities tends to fluctuate. ExxonMobil’s (NYSE: XOM) dividend yield is 4.09%. Brookfield Renewable Partners (NYSE: BEP) offers a 3.31% dividend yield.
Consumer goods products can also be regular dividend payers. Everyone will always need these products, no matter the state of the economy. They pay less than other sectors, but the stocks are more stable over time.
Tobacco companies are the ones who pay the most. Philip Morris (NYSE: PM) and Altria (NYSE: MO) pay 5.30% and 6.77%, respectively. Meanwhile, Coca-Cola (NYSE: KO) and Walmart (NYSE: WMT) pay 2.85% and 1.57%, respectively.
Finance, healthcare, and other industries also pay attractive dividends. ETFs also offer a dividend reinvestment plan and are better for diversification purposes. For more information on dividend-paying stocks, please visit this article.
Overview
What is a dividend reinvestment plan in simple terms? When the company distributes its dividends, investors can reinvest the funds into full or partial shares. Some brokers may charge for the service, but most won’t.
It can be set up when purchasing the stock for the first time or by contacting your broker and adding the option to your existing holding. DRIPs are also subject to taxes, just like regular dividends. Stay current with your tax laws and income bracket, as percentages may change individually.
Pros for Investors
Dividends are guaranteed capital for long-term investors. As long as the price of the shares keeps increasing, investors will be happy. Some companies also offer discounts on shares purchased through a DRIP for existing investors. These discounts can go up to 10%.
For example, Fortis (NYSE: FTS) is an electric utility holding company that offers a 2% dividend reinvestment plan discount.
The newly purchased shares will be discounted compared to the open market price. Over time, investors can also take advantage of price fluctuations in the market, and the returns will be compounded.
It’s also less of a headache for those seeking an automatic investment approach. Finally, investors can own fractional shares. This maximizes the return for every dollar.
Pros for Companies
Companies can also take advantage of their DRIP program. First, they receive more capital for their use. Next, shareholders are less likely to sell their stocks since they are in it for the long run. A relationship is built between both parties that could last a long time.
Dividend Reinvestment Plan Growth Example
The dividend reinvestment plan example below is hypothetical and doesn’t reflect real-life stocks. It is only for the sake of an example.
Stock A is trading at $100 with a 1% dividend yield, so $1 per year. The stock and the dividend price grow by 10% yearly.
You initially buy 100 shares for a total of $10,000. At the end of the first year, you receive $100 worth of dividends, and the shares are worth $11,000, for $11,100.
At the end of the second year, you receive $111 of dividends, and the shares are worth $12,210, for $12,321. If the investor decided to pocket the dividends instead of reinvesting them, his investment and net worth would be worth less. This goes on until you decide the investment is no longer relevant. When could that be?
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When to Stop a Dividend Reinvestment Plan
Investors aren’t obligated to reinvest their dividends. They can put the money in other stocks or their accounts. However, those taking advantage of the dividend reinvestment plan may need to stop the investment one day. There can be many reasons for this decision.
1. The Asset is Performing Poorly
Sometimes, it’s time to move on from a poor investment. While the dividends may be good, the underlying stock may not. If the stock price keeps dropping and there doesn’t seem to be much hope for a recovery, it may be time to pack the bags and look elsewhere.
2. Diversification
If an investor owns too many closely correlated stocks, they may seek out stocks in a different sector. Some investors own a variety of stocks in the energy sector. As we slowly move toward renewable energies, some stocks may appear less attractive in the long term. Diversification will allow us to spread the risk and invest in new industries.
3. Rebalancing the Portfolio
Over time, it is possible to become overweight in a certain type of security due to DRIPs. We may want to keep only 60% of our portfolio in stocks.
Due to constant reinvesting, that number can increase. The idea is to sell a portion of the portfolio to rebalance according to plan. The rebalancing isn’t caused by poor performance but to keep our strategy in line.
That dreaded or exciting period of our life. Everyone’s goals for retirement are different. Some may want to stay near their home and relax.
Others may want to travel and try new things. Depending on YOUR goals, your investment approach will be different.
The first group may want to increase the percentage of their dividend stocks. The second might sell all their stocks and opt for safe investments to maximize their funds today. Both strategies are good, but they depend on YOUR goals.
