Dividend investors are a unique and frankly, quite a passionate bunch! Those of us who have research the topic extensively and believe strongly in it’s benefits understand the impacts it can have on our own portfolios over the long-term. As such, I continue to invest in dividend stocks. However, this has created some unique problems not all investors face when building a portfolio based on a strong and balanced asset allocation. One of these unique problems is what to do with those dividends that hit your accounts? Let’s look at that problem in more detail.[ad#tdg-embedded]
What to do with dividend income
This is an interesting (and good) problem to have. What it means is that as a dividend investor it is imperative that you devise a strategy that guides your decisions around the dividends you receive in your portfolio. As your portfolio grows these dividends can be very significant and must be dealt with.
There are three options for dividend investors. The first is simply to spend those dividends on stuff. This may be relevant to retirees living off their dividends, but as I am focused on building my portfolio out I will not be doing this. I suspect that for most people reading spending those dividends is not in their best interest.
Reinvest in the Same Company
The second options is to reinvest those dividends in more shares of that same stock the dividend comes from. This can be especially relevant if your broker allows you to hold fractional shares. Most brokers only allow you to reinvest dividends if the dividend is big enough to buy whole shares.
I used to buy more shares of the issuing company – I blindly reinvested the dividends into the stocks that the dividends came from. This is an easy strategy to use and takes the guess work out of it. However, my major problem with it was I was not necessarily putting my money into the best opportunities. At any given time in the average person’s portfolio there are better investments than others. With blindly investing in the issuing company, then you may be buying more shares at a company’s high or worse with a company going down the tubes. This happened to me with Bank of America – I bought more shares as the company was imploding. I also like to look for cheap stocks, but BoA had fundamental issues that I did not want to continue buying into.
Reinvest in shares of other companies
I no longer blindly invest my dividends in more shares of the same stock. Instead, I take the third options and let my dividend accumulate and then invest the dividends in what I view as the best options at the time. Sure, this reeks of market timing but as an individual stock investor that is the name of the game (remember – the basis of my portfolio is built with index funds). Through the constant analysis of my stock holdings and looking for more stocks using D4L’s stock analysis service (aff) I decide which stocks I want to put my dividends into.
To sum this issue up, neither strategy is necessarily bad. Spending your dividends will work for retirees or people building a portfolio for spending reasons as opposed to accumulation. Reinvesting into more shares of the same stock can be a good strategy if you have very limited time and believe strongly in all our holdings. My choice is investing in other stocks and not necessarily the same company. Most importantly, you need to choose one that works for your and your investment strategy.