Why reinvest dividends?

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fishdrzig
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Why reinvest dividends?

Post by fishdrzig »

What is the Boglehead philosophy on reinvesting dividends? Is it just a choice and really doesn't matter, or a key element to wealth accumulation?
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Re: Why reinvest dividends?

Post by Call_Me_Op »

Not sure exactly what you are asking. Are you referring to automatic re-investment of dividends, or putting dividends to work in general?
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livesoft
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Re: Why reinvest dividends?

Post by livesoft »

I suppose one can say that saving/investing money is a key element to wealth accumulation. So if one spends money (dividends), then ....
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nisiprius
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Re: Why reinvest dividends?

Post by nisiprius »

Dividends are just part of total return.

While you are accumulating, you would normally be reinvesting the dividends one way or another.

It would not make any sense to put money into your retirement savings portfolio and then take dividends out. It would make more sense just to a little less in.

There are no grand strategic investing-theory considerations here. In general, you would reinvest or not depending on which decision happened to come closer automating whatever it is you wanted to do. In my own Roth IRA, where it's all Vanguard mutual funds, no fees for purchases or sales, and no tax considerations, it makes absolutely no difference at all. In other situations, there might be detailed mechanical nuts-and-bolts issues that might drive a decision.

During accumulation, the natural thing to do is just to check off the "reinvest" boxes, which I think are checked by default, and then execute any strategies about reallocating between funds however often you want and however much you want, as a separate activity.

Certainly, you could decide not to reinvest. In that case, the dividends would accumulate in a money market, earning little, until you took the time to decide what you wanted to reinvest the dividends in. Since dividends are a relatively small dribble of money, it can't possibly make much difference which way you do it, but it's probably just as well not to have a slow leak from hopefully-higher-earning stock and bond funds into low-earning money market funds.

In any case, because dividends are only a few percent of the value of the portfolio, if you tidy up annually, it hardly matters what's happened in between. For example, one might say that in theory, stock funds grow faster than bond funds; and since they (historically!) paid lower dividends than bond funds, if you don't reinvest the difference in growth will be larger and you'll need to rebalance more often, but in reality it's way too small to matter.

I think an awful lot of talk about dividends is outmoded thinking from many decades ago. For example, in Ye Olde Days of fixed commissions and less use of mutual funds and a stiff extra fee for odd-lot transactions, it would have been ridiculously expensive to sell a few hundred dollars worth of a stock or a mutual fund. So, if you wanted to draw retirement income, it would make sense not to reinvest dividends, because they are a steady dribble of income that just happened without your having to pay any transaction costs; and you would have chosen stocks based on how high their dividends were and what months they paid them in.

Conversely, in Ye Olde Days, if you were accumulating, you might favor stocks of companies that offered dividend reinvestment plans (DRIPS) because if dividends got paid out, it would have been ridiculously expensive to buy a few hundred dollars' worth of the stock.
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IlliniDave
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Re: Why reinvest dividends?

Post by IlliniDave »

fishdrzig wrote:What is the Boglehead philosophy on reinvesting dividends? Is it just a choice and really doesn't matter, or a key element to wealth accumulation?
Dividend reinvestment is responsible for an appreciable portion of investment growth. It's the "magic of compounding" at work, especially for things like bonds. I think it's safe to say it's an important contributor to wealth accumulation.

That said, not everyone uses the option to automatically reinvest dividends back into the same fund/instrument that produced them. In my taxable accounts I do not automatically reinvest dividends, I direct them to my money market fund and subsequently use them for rebalancing (I buy more of the undersized component using dividends and ongoing contributions rather than through sales of the oversized component). So they do get reinvested ultimately. I don't know if this hurts or helps or is neutral on wealth accumulation versus automatic reinvestment. It does allow some tax savings if one is inclined to maintain a fixed asset allocation.

For people taking money out of their investments it often makes sense to take the dividends first (since they're generally taxable regardless if you reinvest them or spend them).
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Aptenodytes
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Re: Why reinvest dividends?

Post by Aptenodytes »

Narrowly construed, your question has no answer. It depends on the bigger context in which dividend decisions are being made. You can do very bad things either way, or very sensible things either way.

The basic rules are extremely simple -- stick to your AA and keep costs low. As long as your dividend strategy complies you'll be OK.
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Re: Why reinvest dividends?

Post by YDNAL »

fishdrzig wrote:What is the Boglehead philosophy on reinvesting dividends?
A good savings rate CERTAINLY is what you want to begin with. We want to reinvest to "compound" dividend on dividend on dividend and grow the savings.
fishdrzig wrote:Is it just a choice and really doesn't matter, or a key element to wealth accumulation?
:confused

Depending on magnitude, it may not matter significantly whether you reinvest "when earned" or whether you put aside in a money market account to use in rebalancing. Either way, when accumulating, we want to invest back in the market(s) and time is of the essense. So, it is one element to wealth accumulation (see first quote).
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Re: Why reinvest dividends?

Post by Grt2bOutdoors »

Don't take my word for it, take Rick Ferri's instead. :D

http://www.forbes.com/sites/rickferri/2 ... ends-gone/

The orange line in Figure 1 shows the S&P 500 total return index with all dividends reinvested. The blue line reflects the S&P 500 price only, with no dividends payments. Receiving and reinvesting dividends produced about 8 times the return of price only over the period. Note that the y-axis is a logarithmic scale for better appreciation of the return difference.
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House Blend
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Re: Why reinvest dividends?

Post by House Blend »

It is remarkable how much people can differ about which things are simple and which things are too complicated. And about what "not reinvesting" dividends really means. Some people seem to think it means spending the dividends and investing less. Others seem to think it means letting it sit in a cash account for days or months. It means none of these things to me. I also don't think it matters much for someone who is in the beginning stages of taxable investing.

(For tax-advantaged accounts, it doesn't matter at all.)

Your mileage may vary, but in my taxable account this year, I'm expecting a ratio of dividends to new contributions of about 1:2. I prefer to put all of that money into whichever fund is most underweight, as it arrives. Automatically reinvesting only makes it harder for me to stay in balance.

If Vanguard Fund A is underweight and Vanguard Fund B is about to distribute a dividend, another way to "reinvest" dividends without reinvesting is to login to Vanguard and direct your Fund B distributions to Fund A. In theory you might need to make a change like this every time a fund has a dividend, but if you've been investing for a few years, it is more likely that a fund will stay on an underweight streak for quite a while before new contributions or market movements can change that. (I haven't bought shares of TSM in taxable for more than two years.)
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Re: Why reinvest dividends?

Post by YDNAL »

House Blend wrote:... I also don't think it matters much for someone who is in the beginning stages of taxable investing.

(For tax-advantaged accounts, it doesn't matter at all.)
You discussed personal circumstances, which I ignored for obvious reasons (they are personal), but what does the above mean ? Please explain !!
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Re: Why reinvest dividends?

Post by dbr »

What question are you really asking? There is no Boglehead philosophy about reinvesting dividends because the issue is way down at the level of incidental details about how one keeps one's assets and not at a level of philosophical importance.

To approach this from a philosophical level the principle would be that of maintaining a target asset allocation. Whether or not one reinvests dividends plays a minor role in the sense that when dividends are paid out one has an opportunity to direct those dividends into whatever investment needs to be balanced up. This may or may not be more convenient than selling something to rebalance. The discussion about compounding presented by some above is, of course, correct, but it is a red herring to this discussion. When dividends are paid they are by definition reinvested somewhere. The portfolio as a whole enjoys (funny how we use such an odd word) compound growth according to the asset allocation selected.

A second philosophical principle is that of tax efficiency. A reason not to reinvest dividends in taxable accounts is that one may then be setting up a need to sell something at a capital gains tax cost when the money could have been had by simply using the dividend. This does not apply in tax preferred accounts. In any case this is minor. There is often discussion about the nuances of tax reporting when dividends are reinvested in taxable accounts. While this is important to people actually doing the management of money, it is hardly at the level of Boglehead philosophy.

A issue that can be discussed, again mentioned in some posts above, is that one can spend the dividends. This is also simply a matter of mechanics way down the system from philosophy. There is also the same red herring about compounding. Obviously if one withdraws money from a portfolio, the growth of the portfolio will be less than if the money stayed invested in the portfolio. But this is silly. A person in retirement who wants the money has a portfolio in order to supply it. Whether or not the mechanism is to actually have a dividend check mailed to one and deposited in a checking account to pays bills or one invests the dividend somewhere in the portfolio and next withdraws money from some source in the portfolio is purely mechanics that has nothing to do with any principles. The exception, already discussed, is tax cost management.
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Re: Why reinvest dividends?

Post by Toons »

fishdrzig wrote:What is the Boglehead philosophy on reinvesting dividends? Is it just a choice and really doesn't matter, or a key element to wealth accumulation?
I have always chosen to reinvest dividends as l learned early on that compounding(shares reinvested on more shares)is a key to wealth creation.When I review Quicken data I see that reinvesting dividends in Mcdonalds stock that I have owned for over 2 decades I have been fortunate to average over 10 percent a year compounded growth of initial investment.
WalMart -11% average annual compounded growth. :happy
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Re: Why reinvest dividends?

Post by dbr »

Toons wrote:
fishdrzig wrote:What is the Boglehead philosophy on reinvesting dividends? Is it just a choice and really doesn't matter, or a key element to wealth accumulation?
I have always chosen to reinvest dividends as l learned early on that compounding(shares reinvested on more shares)is a key to wealth creation.When I review Quicken data I see that reinvesting dividends in Mcdonalds stock that I have owned for over 2 decades I have been fortunate to average over 10 percent a year compounded growth of initial investment.
WalMart -11% average annual compounded growth. :happy
I think the OP needs to come back and explain what his question really is. It can't be that he actually thinks one can spend the dividend and still get the compounded return. I think the question is about whether or not one should automatically reinvest the dividend in the investment from which it came or in some other investment. The general answer to that question is that it matters very little or perhaps better, the generic answer to all questions: "It depends."
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House Blend
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Re: Why reinvest dividends?

Post by House Blend »

YDNAL wrote:
House Blend wrote:... I also don't think it matters much for someone who is in the beginning stages of taxable investing.

(For tax-advantaged accounts, it doesn't matter at all.)
You discussed personal circumstances, which I ignored for obvious reasons (they are personal), but what does the above mean ? Please explain !!
Not sure what the confusion is about.

Those comments were made under the assumption that the investor is not behaviorally affected by the reinvest-or-not question. A Boglehead will maintain his AA. So it seems to me that all that matters is whether one approach or another has higher costs. In a tax-advantaged account there are (usually) no trading costs, and no tax costs, so it doesn't matter there.

In a taxable account, the main danger is tax costs. At the beginning stages of taxable investing, if one ends up out of balance, the tax costs of fixing that are likely to be small, hence my opinion that it doesn't matter. (There are also exceptional cases, where you have a fund that charges a purchase fee, but no such fee to reinvest dividends.)
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fishdrzig
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Re: Why reinvest dividends?

Post by fishdrzig »

This is the OP

I think the OP needs to come back and explain what his question really is. It can't be that he actually thinks one can spend the dividend and still get the compounded return. I think the question is about whether or not one should automatically reinvest the dividend in the investment from which it came or in some other investment. The general answer to that question is that it matters very little or perhaps better, the generic answer to all questions: "It depends."[/quote]

Yes, this is what my question should have asked, but I do understand now. Thank you
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BrandonBogle
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Re: Why reinvest dividends?

Post by BrandonBogle »

Personally, I am in the accumulation phase. My taxable account pays out all dividends in cash and I purchase more of my Vanguard ETFs and MFs as appropriate to "rebalance" / keep my AA.

In my Roth IRA, my dividends pay out in cash and I use those funds to buy more of Vanguard's bond funds. This has helped my slide towards more bonds as I get older. I should note though, I've only really been a BH for 6 months now, so I don't have much experience to talk about here. In my pre-BH days, my dividends were in cash and I bought individual stocks according to my AA.
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nisiprius
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Re: Why reinvest dividends?

Post by nisiprius »

The general answer to that question is that it matters very little
Right. Think of it this way. Suppose you have a savings account that earns 1% APY a year. Say you have a checking account that earns 0%. Say you start off the year with $100,000 in savings, $0 in checking, and you don't touch each one for a year.

Now, suppose the bank had offered you two options:

a) The usual one: automatically keep all earned interest within the savings account. "Reinvest the dividends." At the end of the year, you have precisely $101,000 in savings and $0 in checking.

b) An unusual one: each month, have the interest from the savings account automatically deposited into the checking account. Every month, you would see a deposit of $82.95 into your checking account, and at the end of the year you'd have $100,000 in savings and $995.40 in checking. (The reason it's not quite $1,000 is because getting the full $1,000 depended on compounding).

Does it make much difference? No. Would anyone in their right mind opt for not reinvesting? Sure, conceivably. For example, if for some reason it just happened to be convenient to have a cash flow of about $80/month into the checking account, rather than manually doing a transfer every month... something like that. You can imagine other specific scenarios where little details might lead you to have a preference for one or the other.
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Re: Why reinvest dividends?

Post by dbr »

nisiprius wrote:
b) An unusual one: each month, have the interest from the savings account automatically deposited into the checking account. Every month, you would see a deposit of $82.95 into your checking account, and at the end of the year you'd have $100,000 in savings and $995.40 in checking. (The reason it's not quite $1,000 is because getting the full $1,000 depended on compounding).

Does it make much difference? No. Would anyone in their right mind opt for not reinvesting? Sure, conceivably. For example, if for some reason it just happened to be convenient to have a cash flow of about $80/month into the checking account, rather than manually doing a transfer every month... something like that. You can imagine other specific scenarios where little details might lead you to have a preference for one or the other.
As long as we are down to details that "conceivably" actually describes a pretty common case. A person wanting to take withdrawals for spending would often find it convenient to have dividends and interest deposited into a checking account to pay bills. But, as we have now resolved in this thread, that is mechanics and not a guiding principal, excepting tax considerations, and even those are minor. This sort of mechanics should not be confused with those who through some sort of mental accounting raise spending the dividends to the level of being a principle, albeit a misguided one.
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Re: Why reinvest dividends?

Post by EyeYield »

Reinvest during accumulation (working years), take in cash during distribution (retirement years).
Just my basic rule of thumb opinion, which can be sliced and diced a thousand different ways depending on your individual circumstances.
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wander
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Re: Why reinvest dividends?

Post by wander »

fishdrzig wrote:What is the Boglehead philosophy on reinvesting dividends? Is it just a choice and really doesn't matter, or a key element to wealth accumulation?
I do not reinvest dividend in taxable account.
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