This blog post explains what dividends are, and the benefits and risks associated with taking cash dividends versus automatically reinvesting the dividends (known as ‘dividend reinvestment’).
What are dividends?
Dividends are payments made to shareholders of a company or ETF, usually in the form of cash or additional shares. These payments occur regularly, e.g. monthly/quarterly/etc, and are the way that companies or funds share excess cash profits with shareholders. One of the attractive features of investing is the prospect of regular dividend payments over time to shareholders (that’s you).
When a dividend payment is made, an investor will receive an amount based on the number of shares they hold in the company or ETF. The dividend is paid to the investor in cash or can be reinvested into additional shares, depending on the investor’s preference.
Benefits of taking dividends as cash
Taking dividends as cash has advantages for some investors.
It provides a cash return on investment and allows investors to control how they use that cash (e.g. pay bills, invest more in the markets, etc).
Dividends provide an income stream that can also help investors weather market volatility (e.g. share prices may go up and down, but once a shareholder has been paid a dividend, it’s theirs to keep).
Investors can use the dividend to diversify their portfolios by investing in assets different from the ones producing the dividend income.
Benefits of reinvesting dividends
A dividend reinvestment plan (DRP) allows investors to reinvest all or part of their dividends by purchasing more shares in the company or ETF in which they’re invested.
By reinvesting dividends for additional shares, investors can increase their ownership stake in a company or ETF and potentially benefit from further increases in value.
Dividend reinvestment can benefit long-term investors, as the benefits of compounding reinvested dividends become more evident over time. Investors can also benefit from what’s known as ‘dollar cost averaging’ (the practice of investing small amounts of money at regular intervals) which can be attractive because it means investors will automatically be buying additional shares during times when markets are down (e.g., ‘buying low’).
Investors are still entitled to franking credits (if applicable) on dividends reinvested under a DRP, the same entitlement as if the dividend was taken in cash.
Risks of taking dividends as cash
Taking dividends as cash is a great way to immediately enjoy some of the profits generated by investments.
However, investors risk missing out on the opportunity for compounding returns that can occur when dividends are reinvested.
Risks of reinvesting dividends
Dividend reinvestment is a viable strategy for investors, but it does carry risks.
Investors considering DRP should have a relatively long-term investment horizon so that their investment has time to benefit from the compounding of reinvested dividends.
For a short-term investor, reinvested dividends may mean funds are unavailable to take advantage of other attractive investment opportunities.
By reinvesting dividends, investors are potentially exposed to the risk of over-concentration in their overall investment portfolio, as their portfolio may become too heavily weighted in dividend-paying stocks. As part of Six Park’s service, we regularly review your investment portfolio and will rebalance your portfolio if this occurs (at our cost).
Reinvesting dividends exposes investors to market risk, as the performance of their investments will depend on the share market. However, this risk is mitigated by a long-term time horizon and the effects of dollar-cost averaging.
How to choose taking dividends as cash or reinvesting dividends with Six Park
Everyone’s circumstances are unique.
There may be situations where you prefer to have dividends paid out as cash in your Macquarie Cash Management Account (CMA) instead of reinvesting your dividends.
However, many Six Park clients choose to reinvest their dividends as it helps their account balances grow more quickly, potentially increasing future dividend returns and helping reach financial goals sooner.
The default is that dividends are paid out as cash into your Macquarie CMA, so if you opt to participate in a DRP there are a few steps you must complete. Note – you do not have to pay fees or other administrative costs to participate in the DRP.
When you first signed up with Six Park you would have received welcome letters from the share registries, Computershare and Link Market Services. The welcome letters contain instructions on how to set up dividend reinvestment for each ETF.
We have also produced a helpful Share Registry Guide with step-by-step instructions on how to set up an automatic DRP in Computershare and Link Market Services.
If you need any help, please contact our Client Services Team at [email protected]
This article may contain general financial product information but should not be relied upon or construed as a recommendation of any financial product. This information has been prepared without taking into account your objectives, financial situation or needs.
For further details on our service please see our Financial Services Guide at http://www.sixpark.com.au. Past performance is not a reliable indicator of future performance.