Budget Sense

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?

Money is something we should enjoy and use for good. It is not something we should stress about or cling to at all costs, otherwise, what is the point really? The idea is to feel good and express gratitude about your ability to spend on things you enjoy and brings you and those around you joy, great experience and utility. So how do you achieve this? It starts with being financially efficient.

Financial efficiency is a simple concept that is lost on many: it is basically your ability to stretch your money, where you are spending it on things that matter the most and bring you the biggest value, while reducing wasting it on useless things.

Peak financial efficiency is to maximize the gap between the two: spending money on things that give you the greatest value – be it joy, utility or other measures- while being ruthless with wasteful spending , be it fast food, unnecessary monthly subscriptions etc.

But problems arise when you are not even sure what is useful and what is considered wasteful and in fact may even mix the two, thus completely ruining the definition of what it means to be efficient with your money and finances. In that case, you need to do an audit of your weekly and monthly spending and decide on each item: whether it is something that you are using and can’t live without. Is it something that makes you happier? Does it make your life better and more convenient? How much does it cost compared to the utility you are getting back? For example, let us take a hypothetical monthly GYM membership that costs $60. On the surface, having a GYM membership is money well spent given the huge health and mental wellness benefits. But that is only if you are actively using your membership and going at least 2-3 times a week, on a consistent basis. Otherwise, if you hardly ever go – say once a month – then this otherwise great use of money turns into waste and you are better off eliminating it by cancelling the membership. Just walk outdoors instead.

On the other hand, if time with family means the most to you, then spending money on a Netflix subscription wouldn’t be such a bad idea, as you can watch and socialize together. At the end of the day, what is considered useful or wasteful is subjective and may vary from one person to the next. I may value having a car even if total mostly expenses is in excess of $500 while someone else may view that as total waste and would rather just take public transportation.

It is said – backed by research- that most millionaires achieved their status by being extremely efficient with their money. They reduced wasteful spending almost to a science, while turning the act of spending their money on useful things into a work of art. In other words, being financially efficient with your money will translate into financial stability and security in the long term.