Many investments can pay dividends – stocks, mutual funds, index funds, exchange traded funds to name a few. Owners of these investments have to make a choice as to what will happen to the dividends. Dividends can be taken in cash or reinvested.
Cash dividend option
Dividends can be taken in cash which leads to different possibilities:
- The money will be mailed to your house or deposited into your bank account. This is a good option if you are using the money to supplement your income. This option is usually only available in taxable accounts. Keep in mind that these dividends are taxable income so depending on your tax situation, you might have to keep a cash reserve for taxes.
- The money will stay in the investment account. This option is normally chosen by an investor who doesn’t need the income from their investments just yet. The investor can use the cash to buy different investments than the one which produced the dividend.
Reinvest dividend option
A different option is to reinvest the dividend. Any dividend stays in the investment account and is used to buy more units or shares of the investment that produced the dividend. Dividends in a taxable account are still considered taxable income – even if they are reinvested.
- Mutual funds – Most mutual funds automatically reinvest any dividends to buy more mutual fund units unless the investor asks to receive the dividend in cash.
- Stocks - Dividend stock investors sometimes like to use their dividends to buy more shares of their favorite stocks. Similar to compound interest, dividends can help increase the value of your investment. A DRIP is where you can buy a dividend stock and then use the dividends to continuously buy more stock.
Did you enjoy this article? If so, you can get the latest articles delivered to your email inbox for free every Monday morning by entering your email address in the box below. Check out the 'About' page for more information on this site. Your email will only be used to deliver this subscription and you can unsubscribe at any time.
{ 3 trackbacks }
{ 6 comments }
I think the best way to decide is on the need required … take note I mentioned NEED, not WANT.
If this is a retirement income, I would suggest taking it
But if you building your retirement income, I would suggest reinvesting it.
It’s your resident Dividend Addict scouring the web for relevant dividend articles!
Great site and even better article on dividends! I’ll feature it tomorrow for all the Dividend-a-holics on the DA site
Cheers,
DA.
Hello,
This is a classic conundrum for which I hope I can shed light on.
There are 3 key reasons why you should “Cash Out”:
1) To take a Profit:
This is one of the most important rules of investing. You should take some profits while they are available! Until you sell the stock or cash-out on dividends, you will not have made a penny. Therefore, you should reap the benefits of your investment when it is presented to you. Think of it as an apple tree. When the apples are nice red and ripe you pick them for eating or for storing. If you don’t, then they may rot away, no longer being available. It’s the same thing with dividends.
2) For Diversification:
You should use the cash to Diversify into other investments. This way, if your stock that pays this dividend goes bad, then you won’t lose more money with it since you will have used the “earned” cash to buy something else.
You can even buy other dividend-paying stocks you want and continue with the same strategy; this way you would increase your overall portfolio of dividend-paying stocks while diversifying more. Be sure to diversify into different sectors (Oil, Consumer Staples, Financials, etc.)
3) For Tax reasons:
In most tax-jurisdictions, dividend payments are usually taxed at a much lower rate than other types of investment income (such as interest income or capital gains). So, this can save you even more money on your post-tax investment income.
Good Luck!
I’m no genius, but it seems that the attitude to stocks is that you can only make money if they go up, what happens if (like now) the trend is downwards?
Rather than diversifying, as a means of managing the risk, could you not buy an options contract to sell your stock at a price that locks in your profit? If the dividend that you receive can pay for the contract, you have invested risk free, which is surely better than buying other stocks that you have no guarantee will not bomb also.
My RRSP is with CIBC and they don’t give me the choice – I have to reinvest.
Keep in mind, I’m not self-directed yet … I assume, once I’ve completely set this up, I’ll have the choice?
The waterfall drop in almost all assets classes proves that dividends be taken in cash and reinvested in safe investments. That way you systemically sell stocks regularly. So when the inevitable selling hits everyone’s portfolio, you have a stash untouched and you don’t have to guess when the selling will stick.
I started this approach in 2005. So I still have dry powder.
Comments on this entry are closed.