Is it a Good Idea to Reinvest Dividends?

Is it a good idea to reinvest dividends?



ANSWER:

Reinvesting your dividends can be a powerful way to compound long term returns AND significantly increase your income over time. For a full description and illustration of the process, check out the Reinvesting Dividends page.

Simply put, dividend reinvesting is using the dividends received from a stock to purchase additional shares of that stock, which in turn increases the future dividend income. Reinvesting can be done directly with a company (if they offer a DRIP program), or more commonly with most online brokers.

One huge advantage with either of these approaches is that the additional shares purchased through reinvesting are commission-free.

In general, I would agree that it is a good idea to reinvest dividends.

But I would also add one huge warning: Be sure to invest in only the very highest quality companies you can identify. Never, ever, ever be seduced by a high yielding, and high risk, stock simply because the dividend payout is enormous.

Dividend safety trumps dividend yield.

I would much rather take my chances with a low yielding and highly stable stock like Proctor and Gamble with an impressive, long term dividend growth rate than say, something like an Allied Capital that for a while sported a double digit yield until the credit-based house of cards all came crashing down.

Remember that the value of your reinvested shares are totally dependent upon the value of the underlying business itself. Who cares how many reinvested shares you acquire if it's only a matter of time before the stock implodes. If and when that happens, you'll lose both your capital AND your cash flow.