The dividend dilemma: Reinvesting vs taking cash

One of the perks of owning shares is being paid dividends. Most companies pay dividends twice a year, after announcing their full-year or half-year results. 

An important decision that needs to be made is how you'd like the dividends paid - do you want to reinvest them to get additional shares in the company or do you prefer to get them as cash? 

This list of pros and cons may help you work out which option is best for you. 

The pros of reinvesting dividends

You benefit from compound interest  

Reinvesting your dividends taps into the power of compound interest. When you reinvest any earnings, like dividends or interest, your original investment plus those extra gains work together to boost your returns even more.

When you use dividends to buy more shares, it will also increase the dividends you receive the following year. Over a long period, compound interest has the potential to see income increase significantly. 

It's automated  

Dividend reinvesting provides an automated investment - there is nothing that you have to do to build your portfolio every time income is paid. 

There are cost advantages

There are no brokerage fees associated with the shares issued as part of a dividend reinvestment plan, although it is worth noting that we live in a time when brokerage has never been cheaper, reducing this advantage somewhat. As well as not having to pay brokerage, the shares may be issued at a small discount, providing a second cost advantage. 

The cons of reinvesting dividends

Record-keeping can be complex

Historically, the record-keeping for dividend reinvesting has been challenging for investors. For example, if you own a holding for 15 years and receive two dividends a year, that creates 30 purchases that you have to keep track of to calculate capital gains when you sell. This disadvantage has been somewhat offset by improved record-keeping options for portfolios, but it remains a factor to be aware of. 

You could be 'wasting' some of the money

Another challenge is that money that does not buy a 'whole' share is held over to the next dividend period rather than being put to work somewhere in your portfolio. For example, a $50 dividend in a company with a share price of $20 would see two shares purchased, and $10 'left over' until the next dividend period. This is not a big deal for a company with a share price of around $4 like Telstra, however, an investor using a dividend reinvestment plan with Rio Tinto, with a share price of around $120, might see larger sums of money waiting for the next dividend period before being put to work in the market. 

There's a lack of strategic allocation of funds

When you choose to reinvest dividends, you are essentially saying that the company you are reinvesting in is the optimal investment that you can make at that time. If you reinvest dividends in Telstra, for example, you are saying that from an asset allocation, share selection and personal finance strategy perspective Telstra shares are the best decision to make at the time when the dividend is paid. 

If, rather than using the dividend reinvestment plan you received the cash, you would be in a position to decide which asset class, which underlying investment, when and how (i.e. through your superannuation, in your own name, or even a non-investment strategy such as making an additional mortgage repayment) you use the dividend. 

You don't get to enjoy any of the cash  

Receiving dividends is a great benefit of investing and I think there is value in enjoying at least some of the benefits of receiving cash dividends. Receiving a cash dividend from an investment and spending part, perhaps even a small part, of that cash on something that can be enjoyed (even as small as a favourite snack, something to read or a couple of movie tickets), is a tangible reminder of the benefits of investing, and a reward for making the effort to save and invest. 

Key takeaways

'To reinvest or not to reinvest' is a topic that doesn't seem to have a definitive answer. Perhaps early on in a person's investment experience the automation, simplicity and cost-free access to compounding might put dividend reinvesting plans a little ahead of cash dividends. As portfolios grow and mature, the ability to use a cash dividend to make strategic decisions might put cash ahead. Either way, thinking about which approach best suits your situation makes sense.