Dividend investors are a unique and frankly, quite a passionate bunch! Those of us who have research the topic extensively and believe strongly in it’s benefits understand the impacts it can have on our own portfolios over the long-term. As such, I continue to invest in dividend stocks. However, this has created some unique problems not all investors face when building a portfolio based on a strong and balanced asset allocation. One of these unique problems is what to do with those dividends that hit your accounts? Let’s look at that problem in more detail.[ad#tdg-embedded]
What to do with dividend income
This is an interesting (and good) problem to have. What it means is that as a dividend investor it is imperative that you devise a strategy that guides your decisions around the dividends you receive in your portfolio. As your portfolio grows these dividends can be very significant and must be dealt with.
Spend it
There are three options for dividend investors. The first is simply to spend those dividends on stuff. This may be relevant to retirees living off their dividends, but as I am focused on building my portfolio out I will not be doing this. I suspect that for most people reading spending those dividends is not in their best interest.
Reinvest in the Same Company
The second options is to reinvest those dividends in more shares of that same stock the dividend comes from. This can be especially relevant if your broker allows you to hold fractional shares. Most brokers only allow you to reinvest dividends if the dividend is big enough to buy whole shares.
I used to buy more shares of the issuing company – I blindly reinvested the dividends into the stocks that the dividends came from. This is an easy strategy to use and takes the guess work out of it. However, my major problem with it was I was not necessarily putting my money into the best opportunities. At any given time in the average person’s portfolio there are better investments than others. With blindly investing in the issuing company, then you may be buying more shares at a company’s high or worse with a company going down the tubes. This happened to me with Bank of America – I bought more shares as the company was imploding. I also like to look for cheap stocks, but BoA had fundamental issues that I did not want to continue buying into.
Reinvest in shares of other companies
I no longer blindly invest my dividends in more shares of the same stock. Instead, I take the third options and let my dividend accumulate and then invest the dividends in what I view as the best options at the time. Sure, this reeks of market timing but as an individual stock investor that is the name of the game (remember – the basis of my portfolio is built with index funds). Through the constant analysis of my stock holdings and looking for more stocks using D4L’s stock analysis service (aff) I decide which stocks I want to put my dividends into.
Summary
To sum this issue up, neither strategy is necessarily bad. Spending your dividends will work for retirees or people building a portfolio for spending reasons as opposed to accumulation. Reinvesting into more shares of the same stock can be a good strategy if you have very limited time and believe strongly in all our holdings. My choice is investing in other stocks and not necessarily the same company. Most importantly, you need to choose one that works for your and your investment strategy.
Very interesting post and honestly I think it’s an important question. I also think the 3rd option is the best because instead of going “blind”, you can actually look for the best dividend opportunity out there. Over time, that could make a significant difference.
At what point do you go ahead and reinvest them? When you have enough to buy 100 shares? less?
very nice blog, interesting assortment of articles… do you invest in preferred shares as well as regular dividend paying stocks? There are some nice preferred yields out there.
I use option 3. One day I will spend the income, but until then I will accumulate cash and invest where I see fit.
Dividend reinvestment is easy, but while the company may be fantastic, the stock may be trading at a price that makes it a poor investment.
A fantastic company is not always a good investment.
Also a company purchased years a go may have a nice yield on cost, but failed to raise its dividend. (A company without a recent dividend increase goes off my list, so so why would I reinvest dividends?)
I truly agree with Brendan!
I’ve been following your blog for several months, and it’s fantastic. I’m just getting started with dividend investing, and it’s been immensely helpful. Thank-you!
I also go with #3, based in part on an “ah-ha” moment I had reading one of Warren Buffett’s letters to shareholders. In it he said that the single most important thing he does for Berkshire is direct the investment of capital. That’s why the companies owned by Berkshire pay out the majority of their earnings to the parent company, so that then they (he) can invest in the best opportunities availalble.
My conclusion was that your option #3 is analagous to his approach – so I stay away from DRIPs and other automatic reinvestment.
I’ve also got a question — how are US dividends taxed for Canadians? I recently invested in a couple of US stocks, and I probably should have researched these first. I noticed that US taxes are withheld from the dividend payment. And of course, I’ll pay taxes in Canada too at tax time. It would appear to have a fairly signficant effect on the yield.
Are there any specific strategies to minimize this, or is it just something we have to factor into our investment decisions?
Thanks,
Jon
I am in the same boat, I only use DRIP in my TSFA because the dividends are too small to make tades with.
another issue you did not mention is concentration. more specifically concentration in the riskiest holdings.
I held RMM.UN in my RRSP, it is quite a risky REIT. however it pays good dividends to compensate you for your risk. but after DRIPing for 1 year I had more shares than I would like to own.
so risky investments pay higher dividends and so if you drip, your portfolio becomes not only more concentrated, but more consentrated in risker assets.
Sorry for so many posts. I should have done some basic web searching before I asked my earlier question regarding tax on US dividends for Canadian taxpayers. Found this article that answers my question, if anyone else is interested:
http://www.collinsbarrow.com/news_showArticle.asp?articleID=66&typeID=25
I just posted five dividend stocks of interest plus a comparison of VTi and SDY, a dividend oriented ETF.
Check it out at my new blog site.
http://lherr.org/ita/
Lowell
You forgot the fourth option…to bank it in a high interest account…lol…Great post.