Optimizing Dividend Returns: Reinvestment vs. Spending

Dividend income is considered one of the most popular and appealing forms of passive incomes, as it not only provides investors with steady passive income, it also does so while giving you potential for further capital appreciation. While neither stock appreciation nor the yield it provides is guaranteed, you have much better certainty with bigger and well established companies, including consistent dividend increases.

So what is the most popular dividend investment approach and which one should you go with? Let us go through them, exploring each in-depth and which one to choose depending on your financial goals and lifestyle etc.

Fully Reinvest (100% DRIP)

With this approach, you allow your bank or investment firm to reinvest all dividends automatically through a Dividend Reinvestment Plan (DRIP) based on your dividend payouts.

For example, let’s assume you own 100 shares of ‘ABC Bank’ stock, and it pays a $1 quarterly dividend (most companies pay dividends on a quarterly basis). This means you receive $100 in quarterly dividends. With a DRIP plan, assuming the stock price is $25 (for simplicity), you will receive an additional 4 shares, increasing your total holdings to 104 shares. There are several advantages to going full DRIP, as it helps with automating things which is crucial for wealth building. In other words, this approach allows investors to reinvest their dividends back into the same stock or fund, purchasing additional shares. Over time, this can lead to compound growth, as the reinvested dividends generate their own dividends. This compounding effect can significantly increase the overall return on investment in the long term. Furthermore, you are getting extra stocks without having to incur brokerage fees or commissions (depending on your bank or investment firm, this may be free to some anyway) .

Important to note that some banks also allow fractional shares so if your dividend payout is not enough for a full share, you get a fractional one.

Hybrid (DRIP where possible and save or spend the rest of the cash)

As mentioned earlier, not all banks or investment firms allow fractional shares. So if you don’t have enough dividend return to get a full share, the balance of that money is paid to you as cash, which you can either keep in your investment account for future purchases, or withdraw to spend it and do whatever else you want with the money. For example, the bank I use for my investments doesn’t have fractional shares. So if I get $50 in a quarterly dividend return for a stock that is priced at $40, I will automatically get one share (DRIP) and the other $10 will go back to my account. If fractional shares was an option at my bank, I would get 1.25 ($50 divided by $40) shares of that stock. This is the approach I have followed for the most part, given that my bank doesn’t have fractional share. This approach is ideal for those who want to see their investment grow, while also enjoying some of their returns at the same time. For example, a lot of time, the quarterly dividend for some stocks in my portfolio will be enough to buy 2 or more shares, and still have cash leftover which I use to either save for future stock purchases, or simply withdraw to spend it as I wish. Best of both worlds!

Fully spend and enjoy it

Of course, there is always the other extreme, where you spend all your dividend returns and not invest any of it. This is ideal for those who have already achieved their objective of financial independence or reached their goal of generating a certain amount of return per year. Even in this extreme case, you still need to watch your investment to ensure your capital is preserved and are only using the dividend returns.

As mentioned, for years , I was on the first option, but have lately made my way to the second and hybrid approach, given some lifestyle, family and economic changes etc. The goal is still to keep growing the portfolio until I reach a specific goal in mind for how much dividend returns I wish to achieve.

Deciding whether to reinvest your dividend returns or spend them entirely depends on various factors such as your age, lifestyle, and financial goals. On one hand, reinvesting dividends can be a sensible choice, especially for those looking to build wealth steadily over time. In fact, various studies confirm that if you invested in the S&P 500 or other stock markets and reinvested the dividends you received, your investment would have grown faster compared to just watching the stock values go up. Dividends play a significant role in how much your investment can grow over time. On the other hand, spending all dividend returns may be suitable for individuals who have already attained financial independence or have specific yearly return objectives in mind. However, even in this latter scenario, it’s crucial to maintain a vigilant eye on your investments to ensure your capital remains intact, with only the dividend returns being utilized.

Ultimately, the decision should align with your unique financial circumstances and objectives. Just don’t reach retirement age or even beyond, and still be stuck on option 1. The obvious question then becomes: you have spent decades building this cash machine, so if you still can’t enjoy it now, when will you?