The pros and cons of reinvesting your dividends

Growing
September 3, 2018

The end of June represents the end of the financial year for many large companies. At this time the company's annual performance is made public. This is also the time they make dividend payouts.

You might be like me in that you're trying to build your wealth. I'm finding the best investments for me right now are companies that pay dividends, so I can reinvest my share dividend. This is a relatively easy way to build my portfolio when I'm strapped for cash. And I also benefit from higher dividend payments in the future, because I’ve increased the total number of shares I hold.

Dividends get taxed

Dividend income is generally taxed, both in Australia and New Zealand. Dividend tax treatments do vary, depending on your location and personal situation.


It would definitely be worth while talking to a financial advisor to make sure reinvesting dividends is right for you, and discuss your tax obligations.

What is a dividend reinvesting plan?

A Dividend Reinvesting Plan (DRP) has often been recognised as a strategy to help you build your portfolio of wealth. Under a DRP, the company provides you, as a shareholder, with the option of reinvesting your dividends in more shares in their company.


Some companies like this because it allows them to maintain a dividend payment policy, while providing an opportunity to increase their own cash reserves.

For shareholders like you and me, offering a DRP is convenient way for us to reinvest our cash in the company. There are two main types of DRPs.


  1. Under a standard DRP, when a dividend is declared, shareholders are offered the option of receiving a cash dividend or receiving an issue of shares. Receipt of cash is generally the default option unless you, the shareholder, opts to reinvest. You're generally required to make this choice before the dividend is paid.
  2. Sometimes a company will announce a bonus issue of cash or shares (I must say I’ve never seen this myself, but apparently it happens). You still have a choice to reinvest your bonus issue or get a cash dividend. Both options are taxable, or may have imputation credits (a form of tax which aims to ensure you don’t get taxed twice) attached to them.

As an example, let's say I owned 1,000 shares in Telstra which were worth $3.40 each. In February 2018, the company declared a dividend per share of $0.11 cents. I could either take the $110.00 as a cash dividend (1,000 × $0.11 cents) or add 32 more Telstra shares ($110.00 ÷ $3.40) to my investment portfolio.

Depending on your portfolio management style, following are a couple of options for how to reinvest your dividends.

Reinvesting dividends for hands-off investors

A traditional DRP can often be implemented directly with the company. If you're a 'set and forget' type of investor, this might be a better option for reinvesting your dividends as a way of helping you to increase your portfolio holdings. 

Pros

  • a number of listed companies, like Fisher & Paykel Healthcare or Spark, who are on the Australian stock exchange and New Zealand stock exchange offer a DRP
  • less effort is required to manage the reinvestment process, and
  • this method does cut out additional broker fees.

Cons

  • companies that do offer a DRP will require you to sign up. This would need to be done with each company you'd want to set this up for, so there's a bit of paperwork to manage before it's set up
  • the dividends / new shares purchased might still be taxed as income, and
  • you can’t choose the share price you buy your shares at.

In addition, not all companies offer a DRP, so if you want to take advantage of reinvesting your dividends you may need to consider alternate ways to reinvest your dividends. DRP investing is also offered by third party transfer agents or brokerages (where you may be able to streamline your DRP application process, but might incur additional share broker fees).

Reinvesting dividends for hands-on investors

Alternatively, you can manage this yourself. This might be a better option for those of you who are quite hands-on with your investing (such as buying and / or selling and watch the markets regularly).

Pros

  • you could use your dividends to build up some cash reserves to purchase different shares when market conditions are right, and
  • you can hold off reinvesting until these shares become undervalued, or decrease in value, to get more for your money.

If you’re a seasoned, active investor, you may even take this a step further by analysing historical dividend payments and share prices to estimate an upcoming dividend payment. Because you’re anticipating your dividend payout this year, you can focus on other market factors such as share price decreases or research which may suggest the company is undervalued. With this guesstimate, and the suitable market conditions for you, you may be able to purchase your closely monitored shares, in anticipation of getting this dividend to recoup your cost of buying shares.

Cons

  • taxes are inevitable, but you'd also need to consider other expenses like fees for your investment purchase, fees for managing your investment, cost of research etc, and
  • it requires a bit more thinking and participation in the process.

Of course, there’s no requirement to make these alternative DRP investments within a certain timeframe. You may want to more or less of your future anticipated dividends for the DRP purchase if you think the share price is favourable.

Then, once you’ve completed your share purchase(s) you’ll be able to track them and the dividends you get with finappster.

Image by Jordan Opel on Unsplash.com.

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