If you own stocks, mutual funds or ETFs that pay a dividend, you will have to consider what to do with the dividends. Reinvesting in the same investment that produced the dividend is probably the most common strategy. But is it the best?
The basic options for dividends are:
- Reinvest the dividends in the same investment.
- Take the dividends as cash, but leave them in the account for future investment in a different investment.
- Take the dividends as cash and withdraw them from the account.
Here are some factors which might alter your choices regarding reinvesting dividends.
1) You can save the cash dividend you withdraw from an account
Just because you withdraw a dividend from your investment account, doesn’t mean that it has to be spent on beer. You can use that money to pay down debt, savings – all sorts of worthwhile things that should help your financial position. This generally would only apply to non-registered accounts.
2) You can reinvest in a different investment
This is sort of a half point – you don’t have to reinvest in the same stock/fund. You can instead direct the dividends to a different stock or mutual fund.
3) Taxes on withdrawals
If the investment is in a tax-sheltered account such as an RRSP, you shouldn’t remove any dividends because that will be a withdrawal and will be considered taxable income. In this case the dividend should always be reinvested within the same investment account. It doesn’t matter if the dividends are reinvested in the same investment or a different one or even left as cash.
4) Taxes on dividends
If the income investment is in a taxable account then the dividend will be taxable. This means that your tax bill will go up and you need to be able to get the money to pay the extra tax from somewhere other than the dividend if you reinvest it.
5) Pay interest on investment loan
If you borrowed to invest then you might be in a situation where you need to get the cash dividends in order to make the interest payments on the investment loan.
6) Reinvestment reduces choice
Setting up a DRIP on a stock or mutual fund means that you are always going to be buying more units of that investment whenever there is a dividend issued. An active investor might want more control over where that money goes so getting the dividend in cash (and keeping it in the account) allows them to choose where and when that money gets reinvested.
What do you think? Would you ever consider not doing a DRIP if one exists?