Dividends - Why the push to reinvest?
"A dividend is a cash disbursement from the company.  The value of the company goes down the same amount of the dividend, so it is analogous to having money in a savings account and taking a withdrawal every month.  Obviously you are going to have less in the end than if you just kept the money in the account. suppose that I own 10 different stocks, and don't reinvest dividends, but keep them on account, and each month or two, as I add more money to invest, either in one of my existing stocks, or perhaps something new, I add whichever dividend amount is currently available in cash to my new purchase, would this strategy provide the same results? Roughly, yes.  Reinvesting dividends is essentially buying more stock at the lower price, which is a net zero effect in total balance.  So if you invested in the same stocks, yes you'd be in the same place.  If you invested in different stocks, then you would have a performance difference depending on what you invested in. The risk is the temptation to take the cash dividend and not reinvest it, but take it in cash, thereby reducing your earning power. That is, is there some particular reason that the brokers are recommending automatically reinvesting dividends as opposed to reinvesting them manually, perhaps not always in the same item? I'd like to think that they're looking after your best interest (and they might be), but the cynical part of me thinks that they're either trying to keep your business by increasing your returns, or there's some UK regulation I'm not aware of that requires them to disclose the effect of reinvesting dividends.    £100 invested in the UK stock market since 1899 would have grown into just £177 after adjusting for inflation. This figure seems ludicrous to me.  I haven't actually measured what the historical returns on the ""UK market"" are, but that would mean an annualized return (adjusted for inflation) of just 0.5%.  Either UK stocks pay a ridiculous amount of dividends or there's something wrong with the math. EDIT I still have not found a definitive source for the real UK market return, but according to this inflation calculator, £100 in 1899 would equate to almost £12,000 today, for an average inflation rate of 4.14 percent, which would put the CAGR of the UK market at about 4.9%, which seems reasonable.  The CAGR with dividend reinvestment would then be about 9.1%, making dividend reinvestment a no-brainer in the UK market at least." Good question, here are some possible answers: Its a Good Idea There is probably some validity to the statictics and having money invested, generally speaking, has proven far more valuable than having it sit in a savings account. It tends to reinforce strength Suppose you own two stocks, one that is a great performer, and one that isn't.  Generally speaking the high performer will pay out more, and if you reinvest more into that stock, you will be wealthier if you contributed equally to both stocks. You might forget People tend to forget to do things that are not in the forefront, and reinvestment is one of those things that slip people's mind.  One of the wealth building tools that people universally recommend is automation.  Reinvesting is a way to automate one aspect of one's financial life.   You might spend it on something else If you put the dividends into your checking account, there is a non-zero chance that it might get put towards something else.  Better to have it out of sight and mind and invested. They make money Generally speaking, the more money you have in a brokerage account, the more the brokerage makes.   So it is good for them, as well as yourself. While there is some attraction to being able to see a balance that is the result of dividend investments, its just far better to have them be poured right back into whatever investment seem appropriate. There is a basis for that if you consider the power of compounding. So, the sooner you re-invest the dividends the sooner the time will give you results (through compounding). There is also the case of the commissions, if they are paid with a percentage of the amount invested they automatically gain more from you. Just my 2cents, though the other answers are probably more complete. Three major advantages that I can think of (and some of these have been pointed out in comments): There can be a good reason if you own shares issued in a different country: For example, if you are in the UK and own US shares and take the dividend payments, you get some check in US dollars that you will have to exchange to UK£, which means you pay fees - mostly these fees are fixed, so you lose a significant percentage of your dividends. By reinvesting and selling shares accumlated over some years, you got one much bigger check and pay only one fee.
There are many reasons, which other answers have already discussed. I want to emphasize and elaborate on just one of the reasons, which is that it avoids double taxation, especially on corporate earnings.  Generally, for corporations, its earnings are already taxed at around 40% (for the US - including State income taxes). When dividends are distributed out, it is taxed again at the individual level. The effect is the same when equity is sold and the distribution is captured as a capital gain. (I believe this is why the dividend and capital gain rates are the same in the US.) For a simplistic example, say there is a C Corporation with a single owner. The company earns $1,000,000 before income taxes. It pays 400,000 in taxes, and has retained earnings of $600,000. To get the money out, the owner can either distribute a dividend to herself, or sell her stake to another person. Either choice leads to $600,000 getting taxed at another 20%~30% or so at the individual level (depending on the State). If we calculate the effective rate, it is above 50%! Many people invest in stock, including mutual funds, and the dividends and capital gains are taxed at lower rates. Individual tax returns that contain no wage income often have very low average tax rates for this reason. However, the investments themselves are continuously paying out their own taxes, or accruing taxes in the form of future tax liability. Firstly, investors love dividend paying company as dividends are proof of making profit (sometimes dividend can be paid out of past profits too)   Secondly, investor cash in hand is better than potential earnings by the company by way of interest. Investor feels good to redeploy received cash (dividend) on their own   Thirdly, in some countries dividend are tax free income as tax on dividends has already been paid. As average tax on dividend is lower than maximum marginal tax; for some investor it generates extra post tax income   Fourthly, dividend pay out ratio of most companies don't exceed 30% of available fund for paying (surplus cash) so it is seen as best of both the world Lastly, I trust by instinct a regular dividend paying company more than not paying one in same sector of industry Usually I've seen people treat the dividend like a separate cash flow, which is discounted if the company doesn't have a well-established dividend history. I've never really seen dividends rolled into a total return chart (except in the context of an article), probably because dividend reinvestment is a nightmare of record-keeping in a taxable account, and most folks don't do it. One of my brokers (TD Ameritrade) does allow you to plot dividend yield historically on their charts. "If a stock is trading for $11 per share just before a $1 per share dividend is declared, then the share price drops to $10 per share immediately following the declaration. If you owned 100 shares (valued at $1100) before the dividend was declared, then you still own 100 shares (now valued at $1000). Generally, if the dividend is paid today, only the owners of shares as of yesterday evening (or the day before maybe) get paid the dividend. If you bought those 100 shares only this morning, the dividend gets paid to the seller (who owned the stock until yesterday evening), not to you. You just ""bought a dividend:"" paying $1100 for 100 shares that are worth only $1000 at the end of the day, whereas if you had just been a little less eager to purchase right now, you could have bought those 100 shares for only $1000. But, looking at the bright side, if you bought the shares earlier than yesterday, you get paid the dividend.  So, assuming that you bought the shares in timely fashion, your holdings just lost value and are worth only $1000.  What you do have is the promise that in a couple of days time, you will be paid $100 as the dividend, thus restoring the asset value back to what it was earlier.  Now, if you had asked your broker to re-invest the dividend back into the same stock, then, assuming that the stock price did not change in the interim due to normal market fluctuations, you would get another 10 shares for that $100 dividend making the value of your investment $1100 again (110 shares at $10 each), exactly what it was before the dividend was paid. If you didn't choose to reinvest the dividend, you would still have the 100 shares (worth $1000) plus $100 cash. So, regardless of what other investors choose to do, your asset value does not change as a result of the dividend.  What does change is your net worth because that dividend amount is taxable (regardless of whether you chose to reinvest or not) and so your (tax) liability just increased." The shareholders have a claim on the profits, but they may prefer that claim to be exercised in ways other than dividend payments. For example, they may want the company to invest all of its profits in growth, or they may want it to buy back shares to increase the value of the remaining shares, especially since dividends are generally taxed as income while an increase in the share price is generally taxed as a capital gain, and capital gains are often taxed at a lower rate than income. IBM is famous for spending lots of money on stock buyback to keep the stock price higher. The technique works, and investors in growth stocks generally prefer a high market prices to a taxable dividend payment. Dividends are ways to return shareholder value when a company generates a lot of cash, but doesn't have alot of growth. Electric and gas companies are a classic example of high-dividend companies. 449 of the 500 companies in the S&amp;P 500 used 54% of their earnings to buy back shares for over $2 trillion.   Rather than invest in development, capital, human capital, bigger dividends, they're repurchasing shares to boost their EPS and increase share value in the short term. Why is this an issue? Because it shows that these companies are uneasy about the long term. It stunts growth. Doesn't have to be research, simply expansion or rewarding employees/shareholders. Employees of the company receive no benefits and bagholders may make a quick buck short term, but suffer long. Execs of the company however get fat AF checks for hitting target ratios and price. Stock buybacks enable this. "It has little to do with money or finance.  It's basic neuroscience.  When we get money, our brains release dopamine (read Your Money and Your Brain), and receiving dividends is ""getting money.""  It feels good, so we're more likely to do it again. What you often see are rationalizations because the above explanation sounds ... irrational, so many people want to make their behavior look more rational.  Ceteris paribus a solid growth stock is as good as a solid company that pays dividends. In value-investing terms, dividend paying stocks may appear to give you an advantage in that you can keep the dividends in cash and buy when the price of the security is low (""underpriced"").  However, as you realize, you could just sell the growth stock at certain prices and the effect would be the same, assuming you're using a free brokerage like Robin Hood. You can easily sell just a portion of the shares periodically to get a   ""stream of cash"" like dividends. That presents no problem whatsoever,   so this cannot be the explanation to why some people think it is   ""smart"" to be a dividend investor. Yes, if you're using a brokerage like Robin Hood (there may be others, but I think this is the only one right now), then you are right on." Suppose the price didn't drop on the ex-dividend date. Then people wanting to make a quick return on their money would buy shares the day before, collect the dividend, and then sell them on the ex-dividend date. But all those people trying to buy on the day before would push the price up, and they would push the price down trying to sell on the date. Older folk might wish to let the dividends and cap gains be paid in cash, and use that cash towards their RMDs (required distributions).  If you are investing in mutual funds and wish to keep adding to the funds you've selected, the reinvestment is a simple way to avoid having to visit the account and make a new purchase. In other words, you invest $5500, buy the fund, and X years from now, you simply have more shares of the fund but no cash o worry about.  The pro is as mentioned, and the con is really for the 70-1/2+ people who will need to take their RMDs. (Although even they can take the RMD in kind, as fund shares) If you are looking to re-invest it in the same company, there is really no difference. Please be aware that when a company announces dividend, you are not the only person receiving the dividend. The millions of share holders receive the same amount that you did as dividend, and of course, that money is not falling from the sky. The company pays it from  their profits. So the day a dividend is announced, it is adjusted in the price of the share. The only reason why you look for dividend in a company is when you need liquidity. If a company does not pay you dividend, it means that they are usually using the profits to re-invest it in the business which you are anyway going to do with the dividend that you receive. (Unless its some shady company which is only established on paper. Then they might use it to feed their dog:p).  To make it simpler lets assume you have Rs.500 and you want to start a company which requires Rs 1000 in capital : - 1.) You issue 5 shares worth Rs 100 each to the public and take Rs 100 for each share. Now you have Rs 1000 to start your company. 2.) You make a profit of Rs 200. 3.) Since you own majority of the shares you get to make the call whether to pay Rs.200 in dividend, or re-invest it in the business. Case 1:- You had issued 10 shares and your profit is Rs 200. You pay Rs. 20 each to every share holder. Since you owned 5 shares, you get 5*20 that is Rs.100 and you distribute the remaining to your 5 shareholders and expect to make the same or higher profit next year. Your share price remains at Rs.100 and you have your profits in cash. Case 2:- You think that this business is awesome and you should put more money into it to make more. You decide not to pay any dividend and invest the entire profit into the business. That way your shareholders do not receive anything from you but they get to share profit in the amazing business that you are doing. In this case your share price is Rs. 120 ((1000+200)/10) and all your profits are re-invested in the business. Now put yourself in the shareholders shoes and see which case suits you more. That is the company you should invest in.  Please note: - It is very important to understand the business model of the company before you buy anything! Cheers, One reason a company might choose to pay a dividend is because of the desire of influential stockholders to receive the dividend.   In the case of Ford, for example, there are 70 million shares of Class B stock which receive the same dividend per share as do the common stock holders.  Even though there are 3.8 billion shares of common stock, the Class B owners (which are Ford family) hold 40% of the voting power and so their desires are given much weight.   The Class B owners prefer regular dividends because if enough were to sell their Class B shares, all Class B shares (as a block) would have their voting power drop from 40% to 30%, and with further sales all special voting would be lost and each Class B share would be equivalent to a common share in voting power. Hence the Class B owners, both for themselves and for all of the family members holding Class B, avoid selling shares and prefer receiving dividends. Shareholders can [often] vote for management to pay dividends Shareholders are sticking around if they feel the company will be more valuable in the future, and if the company is a target for being bought out. Greater fool theory If you assume the market is always 100% rational and accurate and liquid, then it doesn't matter very much if a company pays dividends, other than how dividends are taxed vs. capital gains.  (If the market is 100% accurate and liquid, it also doesn't really matter what stock you buy, since they are all fairly priced, other than that you want the stock to match your risk tolerance).   However, if you manage to find an undervalued company (which, as an investor, is what you are trying to do), your investment skill won't pay off much until enough other people notice the company's value, which might take a long time, and you might end up wanting to sell before it happens.  But if the company pays dividends, you can, slowly, get value from your investment no matter what the market thinks.  (Of course, if it's really undervalued then you would often, but not always, want to buy more of it anyway).   Also, companies must constantly decide whether to reinvest the money in themselves or pay out dividends to owners.  As an owner, there are some cases in which you would prefer the company invest in itself, because you think they can do better with it then you can.  However, there is a decided tendency for C level employees to be more optimistic in this regard than their owners (perhaps because even sub-market quality investments expand the empires of the executives, even when they hurt the owners).   Paying dividends is thus sometimes a sign that a company no longer has capital requirements intense enough that it makes sense to re-invest all of its profits (though having that much opportunity can be a good thing, sometimes), and/or a sign that it is willing, to some degree, to favor paying its owners over expanding the business.  As a current or prospective owner, that can be desirable.   It's also worth mentioning that, since stocks paying dividends are likely not in the middle of a fast growth phase and are producing profit in excess of their capital needs, they are likely slower growth and lower risk as a class than companies without dividends.  This puts them in a particular place on the risk/reward spectrum, so some investors may prefer dividend paying stocks because they match their risk profile. "Yes, they are, and you've experienced why. Generally speaking, stocks that pay dividends will be better investments than stocks that don't.  Here's why: 1) They're actually making money. They can finagle balance sheets and news releases, but cash is cash, it tells no lies. They can't fake it.   2) There's less good they can do with that money than they say. When a business you own is making money, they can do two things with it: reinvest it into the company, or hand it over to you. All companies must reinvest to some degree, but only a few companies worth owning can find profitable ways of reinvesting all of it. Having to hand you, the owner, some of the earnings helps keep that money from leaking away on such ""necessities"" like corporate jets, expensive printer paper, or ill-conceived corporate buyouts.      3) It helps you not freak out. Markets go up, and markets go down. If you own a good company that's giving you a nice check every three months, it's a lot easier to not panic sell in a downturn. After all, they're handing you a nice check every three months, and checks are cash, and cash tells no lies. You know they're still a good company, and you can ride it out.    4) It helps others not freak out. See #3. That applies to everyone. That, in turn means market downturns weigh less heavily on companies paying solid dividends than on those that do not.  5) It gives you some of the reward of investing in good companies, without having to sell those companies. If you've got a piece of a good, solid, profitable, growing company, why on earth would you want to sell it?  But you'd like to see some rewards from making that wise investment, wouldn't you?     6) Dividends can grow. Solid, growing companies produce more and more earnings. Which means they can hand you more and more cash via the dividend. Which means that if, say, they reliably raise dividends 10%/year, that measly 3% dividend turns into a 6% dividend seven years later (on your initial investment). At year 14, it's 12%. Year 21, 24%. See where this is going? Companies like that do exist, google ""Dividend Aristocrats"".  7) Dividends make growth less important. If you owned a company that paid you a 10% dividend every year, but never grew an inch, would you care? How about 5%, and it grows only slowly?  You invest in companies, not dividends. You invest in companies to make money. Dividends are a useful tool when you invest -- to gauge company value, to smooth your ride, and to give you some of the profit of the business you own. They are, however, only part of the total return from investing -- as you found out."