Dividend reinvestment strategies: What are my options?

Did you know you can get some public companies to pay you a portion of their profits? All you have to do is buy a share of a stock that issues dividends to get started. Some companies reward their shareholders and incentivize more investment by splitting their earnings and paying them out in the form of dividends.

Dividends can be one-time or recurring payments in the form of stock or cash. Companies that issue dividends most often pay shareholders a pre-determined amount of cash per share every three months.

If you invest through mutual funds, you’ll be entitled to receive your dividends. Mutual fund providers typically aggregate the dividends earned on portfolio holdings and distribute the income pro rata to investors, or in proportion to how many shares each investor owns, at least once per year. Mutual funds also distribute realized profits on portfolio investments, paying out capital gains annually.

What can I do with my dividends?

Dividends are a form of income and can provide an additional cash flow that you can use as you see fit. For investments held in a retirement account, you must be mindful of withdrawal restrictions and penalties. However, dividends that are paid in a standard, taxable investment account can be spent any way you choose.

If you don’t have a near-term need for the extra cash, some investors choose to reinvest their dividends into their portfolios. You can do this manually by purchasing a new investment with the dividend cash settled in your account. You can also automate reinvestment; typically, it’s as simple as changing a setting in your investment account or selecting the reinvestment option when you purchase a new investment. This means your dividends will be used to purchase more shares.

There are a few different strategies for reinvesting dividends. A few popular routes include reinvesting the cash directly into the same security, using the money to fund new investments or rebalancing by reinvesting in under-weighted assets in your portfolio. Periodically rebalancing your portfolio can help hedge against volatility and potentially improve your risk-adjusted returns.

Depending on your investment provider, you may be able to automate your rebalancing and reinvestment, too. Although automation gives you less control over the purchase price of your reinvestment, it can help mitigate the risk of emotional biases. The best times to invest often feel like the worst, so our emotions often get in the way of prudent investment decisions. It’s up to you to decide the level of control you are comfortable with, depending on your investment goals.

Should I reinvest my dividends?

Since dividends are a form of income, the reinvestment process isn’t much different from investing other forms of income. First, make sure you have the necessary cash for short-term and emergency expenses. After that, consider how you may want to reinvest your dividends.

Staying invested over the long term matters. Large-cap stocks, small-cap stocks and bonds have generally outpaced inflation over the past 20 years. Even though the interest rates paid by savings accounts have ticked higher in recent years, there is an opportunity cost to holding onto too much cash. Historically, stocks and other fixed-income assets outperform following peak cash yields. Investment return potential is an essential consideration for your long-term savings.

Reinvesting dividends can amplify the compound growth of your investments. Dividends reinvested have the potential to grow. In an analysis of $10,000 invested in the S&P 500 over 20 years, J.P. Morgan found that the portfolio grew to $112,000 by March 31, 2025. If the portfolio had reinvested quarterly dividends, it would have ended at $196,000. While both portfolios followed a similar path in the early years, the effects of compounding grew more apparent over long periods. This is why dividend reinvestment can be potentially beneficial for longer-term savings strategies.

However, one crucial consideration when reinvesting dividends is taxes. Dividends are considered taxable income, whether you choose to reinvest them or not. This means that you must report them on your tax return. The tax rate on dividends depends on whether they are qualified or nonqualified. Qualified dividends are taxed at the lower capital gains tax rates, while nonqualified dividends are taxed at ordinary income tax rates.

Determining whether dividends are qualified can be complex, as it involves factors like the company's structure and the holding period of the stock. Your investment provider typically provides tax statements to both you and the IRS (i.e., Form 1099-DIV) that indicate whether dividends are qualified or nonqualified, helping you understand your tax obligations.

Dividends earned within tax-advantaged accounts, such as IRAs or 401(k)s, are not subject to immediate taxation. This allows for tax-deferred growth, making dividend reinvestment a potentially beneficial strategy for building wealth within these accounts.

The bottom line

Regardless of your dividend strategy, the most important thing to know is that you have control over this extra income. Reinvestment can be a powerful tool to compound your investment returns over time, but dividends can also be a valuable source of passive income. Review your portfolio today and take control of your investment income by speaking with a financial advisor.

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