investing

Dividend reinvesting to boost returns

Highlights
  • Right now, it's generally accepted that the market is not overvalued.
  • "Buying the dips has historically proven to give gains."
  • Most brokerage firms will have a mechanism to allow reinvestment.

Are you one of the many investors sitting in limbo?

If you didn't panic and cash out, but haven't been investing in this scary market either, you probably wonder when you'll ever make a confident investing decision again.

Your time in limbo may be spent more profitably with a modest move -- directing your dividends to be reinvested in your current stock and mutual fund holdings.

"As long as you don't need the income (from dividend payouts), it's generally a good idea to reinvest," says Josh Peters, author of "The Ultimate Dividend Playbook" and editor of Morningstar Dividend Investor.

"The exception is if you have a situation where the market is overvalued," says Peters. "Then, you would be better receiving (dividends) in cash until the market reverts back to a more reasonable level."

Buying the dips

Right now, although experts debate whether stock prices are cheap, it's generally accepted that the market is not overvalued.

Especially if you believe that some time in the not-too-distant future the Dow will again be measured in five figures, reinvesting dividends now looks particularly promising.

"Buying the dips has historically proven to give gains," says Jeff Kleintop, chief market strategist at LPL Financial in Boston.

Dividend reinvestment dovetails with an investing maxim called "dollar cost averaging," which holds that investors do well to consistently invest small amounts of money, says San Francisco financial adviser Milo Benningfield.

Consider, for instance, someone who owns 1,000 shares of GE, which recently paid a 10-cent-per-share dividend. The $100 would buy about nine shares. Optimistic investors who believe that the stock price will gain considerably in the coming months would much rather have the shares than the cash.

Downside details

Kleintop says one factor to consider is if reinvesting dividends would concentrate too much of your portfolio in certain sectors.

Many financial stocks, for instance, pay relatively high dividends, and reinvesting into new shares at today's beaten-down prices could overweigh your holdings in the financial area, says Kleintop. Investors should then sell and reallocate their investments.

Pick and choose

If you hold an investment account at a brokerage firm, it's likely that you can ask that dividends of all or some selected stocks and mutual funds be reinvested.

"It really depends on how complex you get with your investments," says Benningfield. "If you really don't like a holding anymore and you plan to sell it, you may not want to reinvest. Or you might want some dividends in cash so you'll have money to invest when opportunities arise."

Already at it

Investments in 401(k) accounts are typically mutual funds, not individual stocks, says Charles Carlson, CFA and editor of DRIP Investor newsletter. Mutual funds typically reinvest dividends, says Rachel McTague, spokeswoman for the Investment Company Institute, a mutual fund trade group. In fact, it may be that mutual funds in your 401(k) are already reinvesting dividends.

Most brokerage firms, says Carlson, will have a mechanism to allow reinvestment. For example, on its Web site, the brokerage firm Charles Schwab posts, "Automatic dividend reinvestment is available on over 4,000 exchange-listed and Nasdaq stocks."

A fewer number of companies, about 1,100, offer "dividend reinvestment plans" or DRIPS. These companies hold their stock in the individual investor's name, while brokerage houses typically use a "street" name to hold investments of their individual customers. These DRIP companies, which include many recognizable names of the S&P 500, also allow investors to send in money to purchase extra shares without a commission, says Carlson.

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