An important question in portfolio management is whether to invest dividends back into the company that pays them or simply collect them as cash in the account to selectively buy stock in either the company that paid it or in a new position.
Personally, I use both methods to reinvest. In my public DGI portfolio, I choose to automatically reinvest dividends back into the companies that pay them as a way to continuously build out my positions over time. With 51 stocks in the portfolio, if I chose to pool dividends and selectively reinvest, I would only be able to add to a few positions in the portfolio per year rather than to all of them. With this portfolio I am regularly contributing new cash with each paycheck, and I use those funds to add to the positions that I feel are offering the best value whenever I am ready to buy.
On the other hand I have an old SEP IRA from work that I rolled over that is no longer receiving new contributions. So for this portfolio I have turned off auto-reinvestment and collect the dividends until I hit the $500 level in the account, and then use those funds to either add to existing or buy new positions in the account. This gives the benefit of adding diversification over time, and allows me to build multiple positions in the portfolio without having to sell off existing ones to do so.
The problem with this approach is that there is a transaction cost associated with the purchase, while with the auto-reinvestment option most brokerages don’t charge any transaction fees for doing so. This makes it a more cost-effective method than selective reinvestment, especially in smaller accounts.
In the end, either method can produce positive results for investors over time. The most important thing is to DO the reinvesting, the HOW is more a matter of personal preference.
Here are some articles I have either written or found that provide additional information on the topic:
One of the first articles I wrote on Seeking Alpha attempted to answer the dividend reinvestment question by doing a portfolio comparison over a 25 year period. DRIP Or Rebalance? 25-Year Portfolio Analysis To Answer The Question was a theoretical portfolio of four individual stocks which looked at the varied results between automatic reinvestment, pooling of dividends and adding to the underweight position, or simply collecting the cash.
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