Plenty of listed companies offer dividend reinvestment plans, but are you better off taking the cash?
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Dividends have always been one of the key attractions of shares, and a twice yearly dividend cheque - usually with tax credits, is welcomed by many investors.
If you're relying on dividends as a source of income, as many retirees do, it's a no-brainer to take your dividends as a cash payment.
But if you don't need the extra income, reinvesting dividends can be a way to fast-track portfolio growth.
That said, there are pros and cons to weigh up with dividend reinvesting.
A number of companies have dividend reinvestment plans in place (DRPs).
It is a way for listed companies to preserve cash reserves for future growth opportunities.
For the investor, it costs nothing to sign up to a DRP, and it is a chance to grow shareholdings without paying brokerage.
By increasing the number of shares you own, you're entitled to receive even more dividends in the future, and this can really boost the power of compounding returns.
However, there is a key drawback to dividend reinvesting. As far as the Tax Office is concerned, you are regarded as having received the dividends as a cash payment even when they are reinvested.
So the dividend still needs to be included in your tax return.
While investors are usually able to claim franking credits on the dividend to reduce their tax bill, a high income earner paying above the 30 per cent corporate tax rate could face the prospect of forking out for extra tax when no additional income has been received.
As dividends are often paid twice yearly, a DRP can be seen as a form of dollar cost averaging that lets you pay an average cost for shares over time.
That's not a bad thing though you could find that over time a growing chunk of your share portfolio is held in those companies whose dividends you have reinvested. This has the potential to put the balance of your portfolio out of kilter for your particular goals or risk tolerance.
It's also essential to keep good records if you opt to reinvest dividends.
Each share parcel you receive through a DRP will have its own date of acquisition and cost.
So, if you sell a bundle of shares at some stage, you need to be able to pinpoint the date and value of those shares acquired through a DRP to work out any capital gains or losses.
The upshot is that a DRP comes with both pluses and negatives. Dividends are only paid twice yearly at best, so there are faster ways to grow your portfolio. And if you're a high-income earner, reinvesting dividends can come with an annual cash outlay.
It's also worth noting that while dividend reinvesting can see you save on brokerage, very few companies now provide a discount on shares acquired through a DRP.