Why I Recommend to Manually Reinvest Dividends Instead of Setting Up an Automatic DRIP
Answer: Bigger Portfolio Over Time
One of my readers emailed me and asked me if I recommend against dividend reinvesting. She asked how else can I grow my investments. I replied I am not against dividend reinvestment. I just prefer to do it manually so I can pick where to allocate the reinvestment dollars. I also promised to write an article as I am sure there are many of you who may have the same question.
Let me start by stating this for the record.
I want you to reinvest your dividends where possible, if you are in the growth phase of your assets.
Now if you are retired and use the income for your expenses, you should withdraw whatever you need to cover your expenses. If there is anything left over, reinvest.
Here is how I would approach this.
1. If you take an active role in managing your investments
You should actively direct where your dividends are reinvested. Here are some ideas
If you have a defined allocation in your portfolio, put your dividends towards the stocks or funds that have fallen below their allocation percentage,
You could reinvest in the most undervalued stock or fund in your portfolio, or,
If you are so inclined, you can reinvest in the stocks that are doing well to capture the momentum - this can be risky though if you do not pay attention to the valuation
I lean towards value investing so the first 2 options are more in line with my philosophy. The first 2 options are also fairly equivalent to each other - they both prioritize buying when the prices have declined.
This of course assumes that you have a well selected portfolio. If it is a dividend growth portfolio (like our Dividend Fortress portfolio in Founder’s Club), then it is filled with quality names that you will keep for a long term. Using this method, you are taking advantage of volatility or normal price fluctuations and getting new shares when the price dips. Since your portfolio is diversified with a wide variety of stocks in it, you will always have a few that will give you this opportunity to get the shares cheaper.
To do this, I would let the dividends pool in your account as cash, and then periodically (say once a month) check in and reinvest them in the most appropriate stock (or perhaps a few if there are more than one opportunities). You can just set up a recurring appointment on your calendar, say for 25th of each month, to do this. It is a once a month event and will only take you 5 minutes tops to take care of this every month.
Most brokerages today pay a good yield on your uninvested cash, so you are not losing out on any yield doing this.
2. If you want your portfolio to be completely passive
In this case by all means set up an automatic dividend reinvestment plan or DRIP. The goal is to keep the compounding going. DRIP makes it easy to reinvest and you will not miss any reinvestments as it is automatically taken care of for you by your broker. This way your dividend cash will not sit uninvested for weeks until you get around to manually reinvesting it.
Why I Prefer Manual Reinvestment?
I understand my recommendation runs counter to most of the traditional advice on financial sites and perhaps from your financial advisor.
Choosing manual or automatic will not make much of a difference if you only have few years of investing left. However if you have 20-30 years to go before you need to tap your portfolio, you have a very long runway where even a small increase in returns will compound into something significant.
Here is what happens when you manually reinvest in under-allocated stock:
You tilt the odds in the favor of buying stocks at the lows, so your will get larger price appreciation over time, and,
You buy stocks at higher yields because you are buying at lower prices. This will give you a little larger dividend payment every year
You are reinvesting these “little” larger dividend payments and getting “little” more number of shares every time as you reinvest in stocks that have fallen behind (when you set up automatic DRIP, you will end up buying shares even if the stock in question is overvalued).
More shares + Higher Yield quarter after quarter will result in a much bigger portfolio over time. It is just pure math.
Have a question for me? Please reply to this email and let me know.