Should you reinvest dividends or take them as cash? Probably the latter.
When I was a kid, my Mother invested in some stocks. She was hardly a big-time investor, and most of her stocks she inherited from her Father. One was Republic Bank of Texas, which I think Grandpa was on the board of, for a time, as he used to be in banking law (representing Cities Bank, back in the 1960's). (I inherited a small amount of this stock in 1985 and sold it immediately, which turned out to be a good idea).
Of course, Republic Bank went bust in the 1980's, as part of the stock scandals of that era. Oh, you thought 2009 was some sort of new thing? Funny. No it is just a repeat of what has happened, again and again, in our history, since the 18th century.
Anyway, she believed in two things. First, always hold the actual stock certificate, which you keep in your safe deposit box. She didn't trust brokers and wanted to "hang on" to her stocks. Second, always reinvest your dividends, so when you get a dividend, it goes to buy more stock. I am not sure she was right about either of these things. Maybe at the time. Less so, today.
But a lot of people believe in this. The Money Paper had a deal back in the 1990's where they acted as a broker to buy you one share of XYZ stock (which was sent to you, suitable for framing). Once you had one share, you could buy more shares, using the shareholder investment program. So, for example, you could buy one share of Stanley Tool (now Stanley Black & Decker) and then have $100 deducted from your bank account every month to buy the stock. A nominal fee (usually a dollar or two) was taken out as a transaction fee. And, you could have dividends reinvested, sometimes with a fee, sometimes not.
In an era before online brokerages and low-cost or free trades, this was an inexpensive way to buy stocks without having to set up a brokerage account (which back then had a $5000 minimum investment or some such). The cost of investing in stocks, back then, was high. And yes, I did this back in the 1990's before online low-cost brokerages were a big deal. And it was a good way to invest, $100 (or so) at a time.
It also allowed for "dollar cost averaging" which is one of these schemes like "ladder bonds" that some financial sites like to tout. The theory behind dollar cost averaging is that instead of buying stock in one big purchase, you buy little bits over time and pay different prices at different times, and this, for some reason, is better. It does create a capital gains calculation nightmare, particularly in the era before online brokerages and computer calculated gains.
There may be advantages to dollar-cost averaging, I don't know. I've read the arguments and they make compelling sense at the time, and then later on you think about it and say, "Why does that make sense, again?" The main thing, to me, was a way of taking out $100 a month from my checking account (where it would not be missed) and investing in stocks "on the installment plan" so to speak, which is about all the young salaryman can afford. I think that is the real issue, quite frankly.
(There is also the issue of timing the market. If you try to "time the market" and buy low and sell high, usually you end up doing the opposite. Dollar-cost-averaging buys a stock at an arbitrary date, and thus takes your often poor impulses out of the equation).
But today, you can just direct $100 a month from your checking account to go into your online investment account, and then buy stocks (often with zero fees or low fees) so I am not sure the old "shareholder investment program" is still worthwhile. Most companies shunted off this program to a British company called Computershare, and while you can buy stocks through them and reinvest dividends, they do charge a fee for buying stocks. And of course, any fee is more than "zero"- which is what Merrill offers.
But getting away from all that, should you reinvest dividends? Many brokerage accounts (such as Merrill) allow you to do this, and not pay any brokerage fees. So you get a few dollars in dividends and it buys a fractional share of stock. Instead of owning 100 shares, you now own 100.234 shares. It doesn't change your tax consequences at all. And your new shares are bought at a much higher price as well. Fortunately, when it is time to sell, your brokerage account will have your 'basis' calculation ready as well as your capital gains, so you need not save 30 years of brokerage statements and spend hours with a calculator to figure out what you owe in taxes.
What are the advantages of reinvesting dividends? For starters, it is automatic. These little dividend checks are re-invested without your intervention, and re-invested immediately. It is on auto-pilot, and over the years, you may indeed increase your holdings in the company, perhaps even doubling them. There is no need to worry about lost dividend checks, or hassling with tiny amounts to balance your checkbook. For most of us, with diversified portfolios, dividends are not large amounts, as we don't own large amounts of any one stock.
What are the disadvantages? Well, the problem of calculating capital gains seems to be a thing of the past. But I have noticed that whenever a dividend is due, the price of a stock ticks up slightly. Maybe this is because whoever owns the stock at the time gets the dividend. Maybe it is because the company is going to buy shares (if they can't issue more) to use for the shareholder dividend reinvestment program. What is clear to me, is that buying stock right after a dividend it paid does not mean getting the best price on that stock. Also, as the price of the stock goes up over time, you are paying more for the stock.
In a way, it is like reinvesting dividends on a life insurance policy. The dividends are buying more insurance, which is more expensive as you get older, and thus less of a bargain. Better off to take the dividends in cash, or to use them to reduce premiums.
In a way, it is like reinvesting dividends on a life insurance policy. The dividends are buying more insurance, which is more expensive as you get older, and thus less of a bargain. Better off to take the dividends in cash, or to use them to reduce premiums.
Diversification is the other problem. When you put all that dividend money back into company stock, you are not diversifying your portfolio, and this can be disastrous. A friend of mine, for example, inherited a slew of oil company stock from their parents. Dad worked for the company and invested all his money in company stock - and reinvested the dividends as well. Over the years, it built up to quite a pile of stock. All one stock. I asked my friend if they diversified the portfolio and they felt no reason to sell any of it, other than to buy a house and live on. But of course, now that oil is under $40 a barrel, oil stocks are getting hammered, and they have lost 20% of their inheritance. Diversification is the key.
And today, with online trading accounts, you can have your dividends paid in cash into your brokerage account, ready to be invested in something else. Over time, enough money may accumulate in your brokerage account to invest in something else rather than more of the same. Of course, the only downside to this is that you earn no interest while money accumulates in that account.
I have used this latter system to create a portfolio of stocks, mostly dividend-paying boring stocks for companies that actually make and sell things and make old-fashioned profits. Every year, enough dividends accumulate to buy yet another (different) stock, again, not a huge holding, but a small one, which is possible in this era of no-fee trades. So I end up with 50 different stocks in one account, and the account is not dependent on any one stock for its value. (I also have some corporate bonds as well in that account). If one company goes South, frankly I don't care, as the amount invested is pretty small.
So for me, reinvesting dividends doesn't make too much sense for most of my holdings. I would rather use that money to buy something else and thus further diversify my account.
Of course, as we get older, you can also take that dividend money out as cash, as a supplement to your retirement income. But like with interest, it is damn hard to live off of dividends, even if you had a million bucks invested.
I have used this latter system to create a portfolio of stocks, mostly dividend-paying boring stocks for companies that actually make and sell things and make old-fashioned profits. Every year, enough dividends accumulate to buy yet another (different) stock, again, not a huge holding, but a small one, which is possible in this era of no-fee trades. So I end up with 50 different stocks in one account, and the account is not dependent on any one stock for its value. (I also have some corporate bonds as well in that account). If one company goes South, frankly I don't care, as the amount invested is pretty small.
So for me, reinvesting dividends doesn't make too much sense for most of my holdings. I would rather use that money to buy something else and thus further diversify my account.
Of course, as we get older, you can also take that dividend money out as cash, as a supplement to your retirement income. But like with interest, it is damn hard to live off of dividends, even if you had a million bucks invested.
