Dividend reinvestment is the process in which dividends paid out by a company or mutual fund are used to purchase additional shares of the stock or mutual fund.
Dividends are cash payments made to shareholders of companies or mutual funds, often on a regular basis. They are paid out on a per-share basis. Investors have the option of taking these payments in cash and using the proceeds however they see fit — or they can reinvest those dividend payments to purchase more shares of the stock or fund.
For example, if an investor owns 10 shares of a stock or mutual fund valued at $5 a share, and the stock or fund pays out a 50-cent dividend, an investor reinvesting dividends can take that dividend payment ($5 total) and purchase another share. An investor taking cash may simply use that $5 however they wish.
Reinvesting dividends has the potential to accelerate growth of capital. For example, in the aforementioned case, let’s say the investor who reinvested dividends now has 11 shares, at a total of $55. If the stock climbs to $6 a share, the investor now has a total asset value of $66. The investor who took dividends in cash would have 10 shares worth $60 and $5 in cash for a total value of $65.
Investors who reinvest dividends may also benefit should a stock or fund decline in value temporarily. If a stock or fund declines to $4 a share, those 11 shares are worth $44. However, if the stock or fund pays out another 50-cent dividend, the investor can purchase 1.375 shares through reinvestment, for a total of 12.375 shares. (Partial share purchases through dividend reinvestment are common for mutual funds.) Should the share price climb back to $5, the total value of 12.375 shares now stands at $61.875. The investor who took dividends in cash would have 10 shares valued at $5, plus $10 from two dividend payments, for a total of $60.
Many individual equities and mutual funds pay out regular dividends — anywhere from monthly to quarterly to annually — thus giving investors the opportunity to regularly reinvest. While there is no guarantee that a given stock or mutual fund will rise over time, reinvestment of dividends has the potential to make a significant difference in an investor’s portfolio over time. Of course, there are valid reasons for investors to take their dividend payments in cash. A financial advisor can help you decide whether dividend reinvestment is appropriate for your situation and goals.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.