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The HOW, WHEN and WHY of Dividend Reinvestment

How to reinvest dividends to grow your portfolio fast!

What is dividend reinvestment and how can you use it to grow your dough? How do you get paid to invest and why is this possibly the best investing strategy you can use?

In this video, I’ll explain dividend reinvestment plans, how to set one up and two strategies to make your dividends grow faster.

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What is Dividend Reinvestment?

Those of you in the nation know, I LOVE dividend stocks. Seeing those dividend checks hit your account, it just feels like you’re doing everything right and reinvesting those dividends is the best way to grow your portfolio.

But there’s a lot more to dividend reinvestment than just putting that money back to work. It’s not only finding the right dividend reinvestment plan but understanding how taxes work on those cash payments and how to make your dividends work harder.

So I’m going to use this video as a complete guide on dividend reinvestment. I’ll explain DRIPs or dividend reinvestment plans and show you how to set these up even if a company doesn’t have a formal plan. I’ll show you the two ways dividends are taxed and how to make sure you get the most from your money.

I’m then going to reveal two dividend reinvesting strategies, two strategies that go beyond simple reinvesting to make you as much money as possible. I’ll be sharing those towards the end of the video so make sure you stick around.

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Types of Dividend Reinvestment Plans

There are two types of dividend reinvestment we’ll talk about today. The first is a formal dividend reinvestment plan, also called a DRIP. These are set up by a dividend-paying company and allows investors to reinvest dividends directly back into the company to buy more shares.

I’m also going to show you how to create a dividend reinvestment plan on your own, including how to set these up even if the company doesn’t offer it.

I’m going to show you how to set up a dividend reinvestment plan but first, the question of whether you should even reinvest your dividends. I reinvest every penny I receive but there might be instances where you don’t want to do that.

For example, if you need the cash flow to pay living expenses, dividends can be a great source so you don’t have to sell stocks. Depending on how much in dividends you receive, you might be able to live on that alone.

You also might not reinvest the dividends if you’re unsure of where the stock market is heading. Maybe stocks are looking expensive so you want to keep that money in cash or invest it in safer bonds. It’s kind of ironic that people complain all the time about companies buying back shares when prices are high, basically using company cash to reinvest in the shares, but those same investors think nothing of plowing their own dividend money back into the shares.

Normally, for most investors, I would say definitely reinvest your dividends. This doesn’t mean you should reinvest the cash into the same company and we’ll get to a few strategies you can use. But just generally reinvesting your money is going to grow your portfolio faster from those compounding returns.

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How to Reinvest Dividends

There are three ways you can reinvest your dividends. I’m going to show you how to set each one up as well as the pros and cons of each.

The old school way to get into a dividend reinvestment plan used to be directly through the company. So if you wanted to reinvest those sweet 3% dividends from Coca-Cola, you would go to the website and look for its DRIP program. Here we see that Coca-Cola manages its direct stock program through Computershares which happens to manage a lot of companies’ programs.

You can scroll through the companies and click through to Coca-Cola to see plan details, fees and all this other information. So here, you’re investing directly into shares of Coca-Cola through the company, Computershares just manages the program. And every time you get a dividend, it’s going to be reinvested in more stock.

Pros of these direct DRIP programs are that some companies offer a discount on their shares, the fees are usually pretty low and you can usually buy fractional shares. So if you receive a $5 dividend but shares are $50, the program will reinvest your money into a partial share instead of making you wait for a whole share.

Of course the downside to these programs is that you might have shares in ten different companies all on different websites and it can be a pain to keep track of.

The second way to reinvest dividends is going to be through your online investing sites. Most of these are set up the same but I’ll show you on my ETrade account. I’ll go to the dividend reinvestment page here in the menu or I can do a search for dividend reinvestment in the search box.

There’s a drop-down for each account, so make sure you do this for each investment account you have on the site. I can enroll the entire account to reinvest dividends or I can choose to only reinvest dividends from specific stocks.

So down here it lists each dividend stock I have in the account. This is my traditional IRA where I hold a lot of my REITs. And I can see the dividend yield, amount as well as the next ex-dividend date and payment date. Here if I click on a box next to one of these, I can enroll that stock to reinvest the dividends automatically.

I can do that for any stocks in each of my accounts here, so you see I’ve got three accounts, a regular taxable account, a traditional IRA and a self-employed IRA.

The upside to this method is that it makes keeping track of your dividends so much easier. You can keep all your investments in one place and decide which stocks you want to enroll in dividend reinvestment. You get one 1099-DIV tax form each year from the investment site instead of one from each company.

The downside to this is that you can only reinvest dividends from a company into the shares of that same company. To solve this problem, I’ve got a third reinvestment method you should check out.

I originally started investing on M1 Finance for our 2019 Stock Market Challenge portfolio. This was when most platforms charged a commission to buy stocks so I loved M1 for it’s no-fee model. Now that ETrade and most of the other sites have switched to no-commissions, it’s not as much an advantage but I still love the platform for one important feature.

M1 Finance will allow you to automatically reinvest your dividends and any cash across your entire portfolio. All you do is click on this auto-invest link up here and it will give you three options for cash balance control.

You can tell the platform that whenever your account reaches $10 in uninvested cash, you want to automatically reinvest it across the portfolio. You can toggle this second one here to tell the platform when to reinvest or you can turn off the auto-invest feature.

What this is going to do, instead of just reinvesting your dividends directly in the same stock, it’s going to split your money up and reinvest across all the stocks in your portfolio. So when you set up your account, you tell M1 what percentage of your money you want in each stock and that’s what it’s going to use to reinvest your cash.

The advantage here is that you keep a more diversified portfolio. You’re not just reinvesting in one stock but spreading your money across all the stocks you own. M1 also allows that fractional share investing so you get a portion of shares even if you’re not investing enough for a full share.

The downside is that maybe you want to reinvest your money back into that one stock, maybe you don’t want to reinvest across all the stocks in your portfolio. Of course, this is pretty easy to do by just turning off that auto-invest feature and doing the reinvesting yourself.

How are Dividends Taxed?

Taxes on the dividends you receive can be confusing. First of all, you owe taxes on any dividends you collect each year. This is whether you reinvest those dividends or not. If you receive $50 in dividends and reinvest them, you’ll just need to pay the taxes out of pocket come April.

Now HOW dividends are taxed and the rate you pay is the confusing part. Any dividends you receive are going to marked as qualified or non-qualified on the tax form you receive from your broker. Qualified dividends are those you receive on stocks you’ve held for more than 60 days during the 121-day period that begins 60-days before the ex-dividend date.

Now the numbers can be confusing but this is important because it determines the tax rate you pay. Remember, the ex-dividend date is the first day the stock trades without the dividend, so you have to own the shares before that day to get the payment anyway. The IRS says that to get the preferred tax rate on the dividends, you have to own the shares for at least 60 days around this day, and it can be some before, some after, any 60 days around the date.

Any dividends you receive on a stock you don’t own for at least that 60-day period are marked as non-qualified dividends or sometimes just called ordinary dividends.

This is important because qualified dividends are taxed under your capital gains rate, which lower than your income tax rate. On the other hand, those ordinary or non-qualified dividends are taxed as ordinary income.

You see the difference here in the federal tax brackets for single and joint filers. So those qualified dividends are taxed as capital gains and if you make less than $39,375 and file separately, you don’t pay any taxes on these gains.

Dividend Tax Rates
Dividend Tax Rates

This leaves a big question mark in your dividend investing strategy because if you’re not a buy-and-hold investor and you’re selling those dividend stocks in less than 60-days, you could be on the hook for a bigger tax bill.

Let’s just look at a couple of examples here because I want you to understand this and what it means for your investments.

Let’s say you file taxes with your spouse and make $70,000 a year. So we’re looking at the second row under 2019 Joint Filer Tax Brackets. If you own a dividend stock for less than 60 days and collect that payment, you’re going to owe 12% in taxes. If you held the stock for that 60-day period for it to be a qualified dividend, you owe nothing.

One more example, if you file your taxes individually and make $80,000 a year. If you own a dividend stock for less than the 60-days and collect the dividend, you’ll pay a 22% tax rate on that payment. If you hold the shares long enough though, your tax rate falls to 15% on those dividends.

Important stuff here. Your online broker is going to send you a 1099-DIV form with how much in dividends you collected, both as qualified and non-qualified dividends. That’s what you’ll report on your taxes and the difference here could mean thousands of dollars.

Dividend Reinvestment Strategies

Now I want to get to those two strategies for dividend reinvestment. We’ll talk about how much to reinvest and how to determine where to put your money.

How to Reinvest in Dividends
How to Reinvest in Dividends

Our first strategy is going to be following the calendar dividend strategy and this is something we talked about in a previous video but I like to sweeten it with something I call the calendar growth strategy.

If you remember the dividend calendar strategy, basically you’re looking online for stocks with an ex-dividend date coming up. As long as you buy the shares before that ex-dividend date, you get the dividend.

Why I call this the calendar growth strategy is you can sell those shares anytime on or after the ex-dividend date and reinvest in another stock. You take all the money from the sale of that stock, plus the dividend you collected and reinvest it into another stock with a dividend payment coming up.

You keep doing this, reinvesting your profits into the next stock, and watch your money grow!

Dividend Reinvesting Strategies
Dividend Reinvesting Strategies

The next strategy is going to be looking for companies that offer a discount on their dividend reinvestment plans.

There’s currently only two of these; Aqua America, ticker WTR and Franco-Nevada, ticker FNV. But these companies will give you a discount on the share price to invest directly in the company and reinvest dividends.

For example, you get a 5% discount on the share price when you invest in Aqua America through it’s direct stock program and the shares pay a 2.4% yield. Even if the share price goes nowhere for the year, you’ve still made a 7.7% return on that discount and the dividend!

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Dividend reinvestment is one of the best strategies you can use to grow your portfolio and your nest egg. Understand how reinvesting dividends works and how to get the most out of your stocks.

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