Since writing the article on the basics of dividend investing, we’ve read a few questions about the dividend strategy, but one question, in particular, stands out – how to automatically reinvest dividends.
Today’s post will unpack that question a bit and offer our personal perspectives about how we reinvest our dividends.
What is dividend investing?
In case you missed it, dividends are a way for shareholders to participate and share in the growth of an underlying business – because as a shareholder of the company – you own a portion of it.
While there are different types of dividends per se (cash dividends, which are cash payments to shareholders) and stock dividends (a percentage increase in the number of shares owned), when we write about dividend investing here at Cashflows & Portfolios, we are focusing on the cash dividends since that’s how most corporations in Canada reward shareholders.
When you own dividend-paying stocks, and those companies pay out dividends to you as a shareholder, you are essentially receiving some of its retained earnings that a company has already created through its cash flow and profit-making activities.
It’s important to note when dividends are paid, the effect on the balance sheet is a decrease in the company’s retained earnings and its cash balance. In other words, retained earnings and cash are reduced by the total value of the dividend. That may or may not appeal to all investors. Shareholder value is created in many ways!
If you want to read more about the pros and cons of dividend investing, definitely check out our detailed post on this subject. It will help you understand if dividend investing is right for you!
Why reinvest dividends?
You may believe that getting paid to be a shareholder, via dividends, is some key to the holy grail of investing. While there is no magic in the power of dividend investing, it can be a very powerful investing approach all the same.
That’s because reinvesting dividends can take advantage of compounding.
Reinvesting dividends can help your money make more money
The magic of compounding is one of the definite pros of dividend reinvestment.
For example, say you own $10,000 in stock. (You bought 100 shares at $100 each.)
This company pays a $3 annual dividend. So, the dividend yield is about 3% (annual dividend/share price).
The annual dividend growth rate for the stock, however, is 5%, which is not uncommon.
You will also get some annual price appreciation as well, say 4%.
Say also you buy and hold this stock for 30 years since you know from Cashflows & Portfolios that compounding is important – you’re just not sure how important. Well, take a look:
Reinvested dividends not only delivered a greater annualized return, in terms of real money you can actually spend, it added almost $40,000 to your bank account by you doing nothing but reinvesting your dividends.
Money that makes money, can make more money over time.
Dividend reinvestments can be automatic
Another benefit of reinvesting your dividends is it can be automatic. That is, there is no thinking involved.
Once you establish your reinvestment plan with your discount brokerage, usually as easy as a phone call to your brokerage, you can then reinvest all dividends paid; cash dividends are automatically invested by your brokerage into a stock (or ETF) you liked enough to buy and hold in the first place.
Given bad investing behaviour such as trading or thinking you can time the market is usually detrimental to your portfolio value, then automatically reinvesting dividends into more shares of a security can help you curb any bad behaviour and even more so, reward you with time.
That’s because when markets go down, you are reinvesting your dividends at lower stock prices. When markets go up, you get the share price appreciation on the ride back up.
Dividend reinvestments are free!
As Do-It-Yourself investors at Cashflows & Portfolios, we know that buying (or selling) stocks or ETFs often comes at a cost – with commission fees paid to the brokerage we use.
So, a HUGE advantage of reinvesting our dividends is to reduce commission fees. In that, it costs nothing to automatically reinvest our dividends.
In summary, we can take advantage of the power of compounding, we can better manage our investing behaviour, and we can do that all for free by automatically reinvesting our dividends.
Are there drawbacks to reinvesting dividends?
Yes, so it’s worth mentioning the other side of the story.
The biggest one is the need to calculate your adjusted cost base – if you are investing in a taxable account.
When you buy an investment in a non-registered/taxable account, the eventual sale proceeds need to be reported on your tax return. When that sale is triggered, you could have a capital gain or a capital loss.
If you have reinvested dividends, your adjusted cost base is more complicated because you must factor in the amount reinvested over time, as in every month or quarter.
If you own assets other than Canadian stocks in a taxable account, and you reinvest those dividends, things get more complex because for tax filing purposes your adjusted cost base (ACB for short), must be reported in Canadian dollars. What this means is, every reinvested dividend must be calculated in Canadian dollars. You can probably appreciate the tax complexity now reinvesting dividends in a taxable account, in a foreign current no less.
Of course, these ACB complications are only relevant for taxable investing. The great news is, if you are investing in a tax-free way (TFSA) or via a tax-deferred way (RRSP), you will not need to worry about ACB calculators whatsoever. It’s a non-issue.
If you want to know everything there is to know about how to invest inside your TFSA and RRSP, wisely, read our comprehensive posts below:
How to automatically reinvest dividends
Like we mentioned above, for many discount brokerages including Questrade (with whom some of us at Cashflows & Portfolios have used for years), how to register your entire account or enroll only some of the securities you own in a dividend reinvestment plan is as simple as a phone call to your brokerage – to tell them to do so.
Just be mindful that reinvesting dividends with your discount brokerage usually purchases whole shares only (not partial shares).
A quick example:
Say you own 100 shares of Company ABC currently priced at $18/share. ABC declares a quarterly dividend of $0.20 per share. This means you get paid $20.00 for the 100 shares you own.
Dividends by ABC are paid quarterly, so you get $20 every 3 months unless ABC decides to raise, lower or stops their dividend payments to you.
Now, you have a few options about what to do with your $20. Let’s look at those:
- You could take the $20 in cash. ABC will deposit the cash directly into your discount brokerage account.
- You could automatically reinvest dividends in a dividend reinvestment plan (commonly referred to as a DRIP).
- 100 ABC shares paid you $20 in dividends.
- ABC share price today is $18.
- Your synthetic DRIP would buy you 1 whole share of ABC (@ $18.00) and the rest would be paid in cash ($2.00).
- You now own 101 ABC shares.
This plan will repeat for you every quarter so long as ABC pays a dividend and you own enough shares to reinvest one (1) full share.
Now, the stock price of ABC shot up AND you got a dividend raise. Good news!
How does this impact your DRIP?
- You now own 101 ABC shares (remember, you got 1 whole share reinvested last quarter).
- Luckily, ABC company raised their dividend for you from $0.20 per share to $0.22 per share
- Your 101 ABC shares now pay $0.22 per quarter.
- Your 101 ABC shares just paid you $22.22 in dividends (101 * $0.22).
- ABC share price today is $19.
- Your synthetic DRIP would buy you 1 whole share of ABC (@ $19.00) and the rest would be paid in cash ($3.22).
How to automatically reinvest dividends summary
We believe automatically reinvesting your dividends is a great way to get wealthy eventually.
By reinvesting your dividends, your investments can generate more money on their own through the power of compounding, reinvesting dividends can help you stay invested over time regardless of market conditions, and reinvesting dividends can come at no additional costs to you depending upon the accounts you invest within.
We encourage you to consider this approach to build more wealth and be savvier about investing at the same time. For our personal portfolios, we will continue to follow this approach ourselves. Using this strategy at Cashflows & Portfolios has enabled us to build our respective 7-figure portfolios to start thinking about early retirement and/or working on our own terms.
We know learning how to automatically reinvest dividends can work for you too.
Further Reading and Offers:
Check out one of our favourite discount brokerages in Canada – Questrade offers no-fee investing when buying low-cost ETFs. You can also reinvest your dividends and distributions using ETFs with Questrade for free. If you are interested in opening an account with Questrade, sign up with this link to receive a $50 trading credit.