Is It Better to Reinvest Dividends or Not?

How to choose whether to reinvest dividends or use them as income

Couple discussing their dividend reinvestment strategy with a financial advisor.
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One of the most important questions you will face as a new investor is whether to treat the dividends you receive from your stocks as extra income or whether to reinvest them for future growth.

Treating dividends as income and reinvesting them are both viable investment strategies, and each comes with trade-offs that impact your ultimate net worth and the lifestyle you are able to lead.

How to Reinvest Dividends

When you receive dividend payments from a stock that you own, you have two options:

  1. Treat dividends as income.
  2. Reinvest dividends to buy more of the same stock.

Many stocks have dividend reinvestment plans (DRIP) that allow you to buy more shares of the same stock by automatically reinvesting those dividends, rather than having them deposited into your checking account.

DRIP plans are helpful to small investors because they allow you to buy fractional shares.

Not all companies allow this option. And not all investors choose to reinvest even when it is available. Which choice you make should depend on your own short- and long-term financial goals.

What Happens When You Don't Reinvest Dividends

When you don't reinvest your dividends, you increase your annual income, which can significantly change your lifestyle and choices.

For Example

  • You invested $10,000 in shares of XYZ Company, a stable, mature company that is also a popular income stock, in 2000. This allows you to buy 131 shares of stock at $76.50 per share.
  • You do not reinvest your dividends.
  • By 2050, you own 6,288 shares as a result of stock splits, trading at $77.44 per share, or a $486,943 market value for your entire position.
  • Over those 50 years, you also receive dividend checks totaling $136,271.
  • Your $10,000 turned into $613,214.

While not sufficient to replace a full-time income, your dividends in this scenario would provide a substantial amount of extra spending cash that could be used for emergency expenses, vacations, education, or simply to supplement your regular take-home pay.

On top of that, you would ultimately have $486,943 in shares sitting in your brokerage account, which could generate significant additional dividend income or serve as a large portion of your retirement income.

What Happens When You Do Reinvest Dividends

When you do reinvest your dividends, you lose the additional cash flow that they could have provided in your daily life. However, you benefit from even more significant compounding. As your dividends reinvest, they buy additional shares, which then generate additional dividends, all of which are also reinvested.

For Example

  • You invested $10,000 in shares of XYZ Company, a stable, mature company that is also a popular income stock, in 2000. This allows you to buy 131 shares of stock at $76.50 per share.
  • You set your dividends to reinvest.
  • By 2050, your 131 shares have grown into 21,858 shares.
  • Because the value of the company has gone up, the market value of your stock is $1,700,000.
  • You retire and start taking annual cash dividends of $42,000.

In this scenario, instead of enjoying extra income over the course of 50 years, you delay using your investments until you retire. At that point, your initial investment of $10,000 has become nearly $2 million, which could fund a very comfortable retirement.

Is It Better to Reinvest Dividends or Not?

Would you rather enjoy over $136,000 in cash along the way, allowing you to pay unexpected expenses or take vacations with your family, and still end up with investments worth a sizeable amount? Or would you rather live more frugally for most of your life but have $1,700,000 and a large annual cash dividend in retirement?

The right answer depends on your financial situation, short- and long-term goals, your personality, and your need for funds. If you make a comfortable income and don't feel the need for a lifestyle upgrade, reinvesting your dividends to fund your retirement could make the most sense.

If you choose to reinvest your dividends, you can still sell stock to cover unexpectedly large expenses, such as a child's education or a medical emergency.

On the other hand, if you need a little extra income to supplement your job, or if you want to enjoy more experiences while you are young (or for your family while your children are young) you could be better off using the dividend payments throughout your lifetime.

In that case, you would still end up with nearly $500,000 in your brokerage account and the annual income from those dividends.

The right choice for you also depends on your level of risk tolerance. In a best-case scenario, you can maximize the value of your investment by reinvesting your dividends. But if the company goes under or the stock market crashes, you could lose your investment just when you need it most—without even having the chance to enjoy the benefits of your dividends along the way.

Ultimately, whether your reinvest your dividends or spend them, you should be using your money and investment as tools to provide you with the highest possible balance of enjoyment and security throughout your life.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

Article Sources

  1. Investor.gov. "Direct Investing." Accessed Mar. 18, 2020.

  2. New York State Office of the Attorney General. "Understanding Common Investments: Stock." Accessed Mar. 28, 2020.