Automatic vs Manual Dividend Reinvestment

[ChadR]

With INTC in a taxable account, you pay taxes on the dividends whether you reinvest them or not.

[Kerim]

Right you are, Chad. Thanks.

[Kerim]

I think I am homing in on a clearer mental framework for this debate, based largely on my thinking about “new” versus “reinvested” money. While I think that manual reinvestment is likely the “right” answer, there is plenty of room and reason for automatic reinvestment.

Once I concluded that I must think about all investable money in the same way (whether from my paycheck or from dividends) and that hence purchases with new money are no different from purchases with dividends, it is easy to see that manual deployment of dividends is the “right” approach. I should want to put my money to its most productive use at any given time, and it does not matter whether I procured that money through my labor or through dividends. So I should take whatever money is at my disposal at this moment and buy my highest-conviction, best-value dividend growth stock at the moment. This means manual reinvestment of dividends.

However, there are some sound reasons that fully manual reinvestment of dividends is not practical or desirable. There are limits to my time and knowledge, and I believe that in some cases it is wise to remove myself from the decision-making. There are some core dividend growth stocks that I want to build a large position in over time. These are stocks that I believe will continue to grow earnings and dividends for many years to come. I am comfortable and happy to decide right now that I’d like to buy more PM each quarter regardless of the price, because I believe that the price will continue to rise over the years as earnings and dividends improve. Moreover, I’m not sure that I trust future me to make the same buys with new money. Like most people, I have psychological weaknesses that may stop me from buying PM when it gets to $100, because I was accustomed to buying it for $85.

So here is the compromise I am headed toward: I will automatically reinvest dividends in what I believe are the best, core dividend growth stocks, like PM, JNJ, PG, KO, MCD, and the such. For non-core DG stocks and other outliers in my portfolio (such as the REITs), like FTR, NLY, ARCP, F, and the such, I will accumulate the dividends in my account along with new money, and will invest in the best values I can find at the time. That may be nothing at all, more of my core stocks (when they hit value territory), or other dividend growth stocks that I do not own yet. I haven’t decided which bucket tech or cyclicals belong in, but I am comfortable doing it case by case.

[hendi_alex]

Sounds like a good compromise plan to me. I don't remember which companies, but in the past I've seen where some companies give something like a 5% discount for drip shares. There certainly is a benefit to participating in that kind of plan. For me, all the others where there is no discount for drip shares, one is likely better off letting all dividends accumulate for a bargain purchase on one of those black swan kinds of days, only buying one or two days per year.

I use to know an investor who stayed mostly in cash about 80% of the time. When there was a huge market drop of 10% or more, he would make a large initial deployment and then feather in upon further weakness. When the invariable rebound took place, he would feather his way back out. It seemed that a couple times per year, he would rake in 10%-15% or more, soundly thrashing me with my technique of usually being 80% or more long at any point and time.

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If a person traded an S&P500 index fund and only used the bollinger bands to determine buy and sell points, how well would they have done in the past 12 months. Let's say that the person bought when the BB were within 5% of the lower band and sold when the chart was within 5% of the upper band, moving 100% between investment and cash on each round trip. It looks to me as if that strategy would have netted at least 30% YTD, and cash would have only been deployed about 50% of the time, holding the duration risk down considerable over a buy and hold strategy. This might be something worth trying with at least a portion of assets. Would the strategy work as well in a generally falling market? I think that it would, but would carry more risk in case there was a large gap down at some point. That risk would probably lends support to a strategy of feathering in during the fall and feathering out during the rise, so that capital always stays in the ready in case something dramatic were to happen.

[EricL]

A good article was just posted by Chuck Carnevale on this subject on SA.

http://seekingalpha.com/article/1881451-...and-invest

[Dividend Mantra]

EricL,

That article was phenomenal. Some people find Chuck verbose, but I appreciate his talents.

I also selectively reinvest my dividends, rather than employing a DRIP. I hate the idea of buying an overvalued security with fresh capital, and hate the idea just as much with dividend income. Makes no difference to me.

[hendi_alex]

D.M., yours is the healthy attitude to have IMO. DRIP is great for anyone who is trying to minimize time involved with managing the portfolio. But if a person would not buy more of the security today with fresh cash, then it makes no sense to buy via DRIP today. For me, cumulative dividends are best directed toward the best opportunity that arises, and Buffet would probably add, [to let the price come to the buyer] rather than buying just because the cash is available.

There are all kinds of strategies and styles, but for the life of me, I can't see buying a stock on a given day just because cash hits the pot, buying without regard to entry price.

As pointed out earlier, just watching the price action relative to the bollinger bands would save 5% more often than not.

Since August look at how many days QCOM could be bought at under $68.


And the same with Aflac, three or four nice opportunities to buy shares in the lower half of the trading range.

[EricL]

(12-06-2013, 08:03 PM)Dividend Mantra Wrote: EricL,

That article was phenomenal. Some people find Chuck verbose, but I appreciate his talents.

I also selectively reinvest my dividends, rather than employing a DRIP. I hate the idea of buying an overvalued security with fresh capital, and hate the idea just as much with dividend income. Makes no difference to me.

I employ both strategies with my portfolios.

I have a 401k account with new money coming in monthly. I reinvest all of my dividends and use my fresh capital to add to positions that I feel are at good values. Recent buys include DLR and DE. I could see myself switching the reinvestment off down the road when the portfolio is larger, but right now as I am working to build capital I am comfortable letting my winners run and letting the compounding work.

In another account I have an old SEP plan that I converted from mutual funds over to a rollover account and invested the proceeds to higher yielding DG stocks. With this account I will accumulate the dividends and direct them into either an existing position or start a new one once I have enough.

Finally, in my smaller cash account I am also taking dividends as cash. This is mostly just to make the accounting easier when I go to sell and again to provide new capital for future purchases.

I really don't think you can go wrong either way. I don't think the end result will be significantly different either way, it just depends on an individual's preference and situation with each account.

By the way, love your blog. You are a great inspiration and your thoughts on keeping investments in a cash account for early retirement have gotten me to do some thinking on my future plans.

With a wife, kid, and another on the way, I can't match your savings rate. But we are nearly debt free other than the mortgage and I'm hoping by the second half of 2014 I can start plowing more funds into building up our retirement savings.

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(12-06-2013, 08:36 PM)hendi_alex Wrote: As pointed out earlier, just watching the price action relative to the bollinger bands would save 5% more often than not.

Your posts on the bollinger bands are interesting. That's not really something I've looked at in the past before making purchases, but will have to start paying attention to in the future.

Thanks for sharing.