Should You Reinvest Dividends or Cash Them Out?

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Dividends are cash payouts you typically receive from stocks. When a company that you own shares of has excess earnings, it either reinvests the money, reduces debt, or pays out dividends to shareholders.

In 2020 alone, the Tax Foundation highlighted that U.S. taxpayers reported $328 billion of taxable ordinary dividends as part of their income. That’s no small sum and many Americans lean on dividend payments to supplement their income.

What Is Dividend Reinvestment?

When you opt for dividend reinvestment, this means you’re purchasing shares of the same dividend-paying stock that paid you the dividend. For example, if you own 100 shares of Company X valued at $10 per share, you own $1,000 worth of stock. If you receive a dividend payment of $0.50 per share, you’ll earn $50. You can elect to reinvest that dividend payment and purchase five more shares of the same stock at the existing share price of $10. This strategy leads to compounded growth over time.

At the same time, you can also cash out the dividends to spend, save, or invest in some other asset rather than reinvestment in the same company. Which strategy is best? Time explains that there are varied pros and cons of both cashing out and reinvesting.

Cashing Out Your Dividends

Pros

• You’ll Have Additional Income Added To Your Cashflow: Dividend payments are a form of passive income. You’ll be able to put them towards necessary expenses or save for a long-term goal.
• You Can Use Dividends To Pay Down Existing Debt: Dividends can be used to pay off or even eliminate existing debt that may be eating a hole in your finances.
• You Can Diversity Your Investments: You can take dividend payments from one asset and use them to purchase other investments. Diversification is key when it comes to smart investing.

Cons

• You’ll Miss Out On Compounded Growth: Dividend reinvestment results in exponential compounded growth as you take the payments and buy more shares of the stock. Those new shares, which were purchased with the dividend, are also paying you dividends. Cashing out instead will preclude you from multiplying your investment.
• It May Take Longer To Achieve Long-Term Financial Goals: Dividend reinvestment leads to compounded growth. This makes it easier (and faster) to achieve your long-term financial goals versus keeping cash in a savings account.
• Your Money Could Lose Value Due To Inflation: Keeping your cash liquid will result in depreciation over time. Keeping the dividends reinvested instead allows your money to grow with the market over time.

Dividend Reinvestment

Pros

• Your Money Will Grow Exponentially Thanks To Compounded Growth: Arguably the best advantage of dividend reinvestment is that it allows you to buy more shares of the same stock and build wealth over time. By purchasing more shares of the same stock with passive dividends, your investment grows further as you reinvest. This way, you earn even more dividends which multiplies your money exponentially.
• It’s Simple And Easy To Reinvest: Once you set up your brokerage account to reinvest your dividends or register with the company’s dividend reinvestment plan (DRIP), the process is automatic. You can opt-out later if you want to change your strategy.
• You’ll Benefit From Dollar Cost Averaging: By reinvesting over time in equal portions at regular intervals, you effectively take advantage of dollar-cost averaging. This limits the inherent risks associated with timing the market. 

Cons

• You’ll Limit Your Asset Diversification: Reinvesting your dividends in a company you already own shares of can result in an unbalanced portfolio.
• You Could Still Owe Taxes: It’s important to note that dividends are taxed whether you take a cash payout or reinvest them. If you choose to reinvest rather than take the cash, you’ll have to pay the tax bill out of pocket.
• You’re Not Liquid: Dividend reinvestment means that your cash is tied up. You won’t be able to spend the money, save, or invest in other assets.

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