Dividend investing is one of the most popular forms of investing. Dividends provide a regular stream of income to investors. You have two options when the dividend accrues on a stock. You can take the cash or reinvest the dividends in the same company stock.
Living off dividends is the simplest plan to generate retirement income— Dividend Growth Investor (@DividendGrowth) August 19, 2020
You buy income producing assets when you work, and you reinvest dividends
Once you hit the dividend crossover point, your dividends pay for your expenses in retirement
How are dividends reinvested?
There are two main ways to reinvest. You can reinvest on your own or most companies provide an option for dividend reinvestment plans (DRIPs). More stocks of the same company are bought automatically with the dividends reinvested with the company.
You could keep depositing dividends in your account and buy more shares for the same security when you think the price is attractive. You may also want to purchase another security with the dividends earned.
Should you reinvest or take the cash?
There are many considerations when choosing between taking cash or reinvesting your dividends. If you choose to hold the stock for the long term, it usually makes sense to keep reinvesting the dividends.
There are many benefits of DRIPs including:
- Commission-free transactions: Usually, you have to pay commissions to brokers to buy stocks. With DRIPs, the dividends are reinvested in the stock automatically.
- Fractional shares: You can’t usually buy fractional shares in the market. With DRIPs, the shares that your dividends can buy are automatically bought in your account, which includes fractional shares.
- Dollar-cost averaging: The companies operating DRIPs usually apply dollar-cost averaging to determine the cost of the shares purchased with reinvested dividends, which avoids buying at peaks and troughs.
However, reinvesting dividends or not is a personal decision that depends on many other factors apart from a return perspective. The need for liquidity could be one of the factors driving the decision. If you need money, you might want to take cash.
The stock with the reinvest option might not be performing according to your expectations or on par with the rest of your portfolio. In that case, you can take cash from the stock and invest where the income expectation is higher. Also, you might want to diversify your portfolio. By taking cash from dividends in a particular stock, you can invest in another stock or asset. Diversification may help you balance your portfolio based on your choices and requirements.
Are reinvested dividends taxed?
Reinvested dividends are taxed just like cash dividends. They are essentially cash dividends that are reinvested to buy more shares. In such cases, dividends could either be qualified or non-qualified. If the dividend is qualified, it would be taxed as capital gains and the tax rate would depend on your total taxable income. If the dividend isn't qualified, it would be added to your total income. You would have to pay taxes on the dividend income at a marginal rate.
The reinvested dividends are taxed just like cash dividends. They are essentially cash dividends that are reinvested to buy more shares. In such cases, dividends could either be qualified or non-qualified. If the dividend is qualified, it would be taxed as capital gains, and the tax rate would depend on your total taxable income. If the dividend isn't qualified, it would be added to your total income. You would have to pay taxes on the dividend income at a marginal rate.