Understanding Dividends and Dividend Reinvestment

June is always considered the lucky month for those who invest in company stocks and shares because it’s a time to get rewards for their financial contribution to the company. For companies, June is the beginning or the end of a financial year and a moment to show gratitude to the company shareholders through dividends. Companies calculate the amount to pay their shareholders in the form of dividends. To avoid receiving lesser dividends than you anticipate, it would be wise to use a dividend growth calculator.

How dividends are issued

Dividends are issued in the form of cash or can be in the form of more shares and stock in the company. Before they are released, the company directors and executives make decisions based on the company’s performance, whether to issue or not issue dividends. The amount received in the form of dividends depends on company performance during the year. In case of losses, companies decline to issue dividends.

Dividend reinvestment

In the pursuit of more wealth, shareholders consider reinvesting their stocks to increase their company ownership and dividends. Dividend reinvestment is an excellent strategy to build personal wealth and has numerous benefits and negative consequences. In summary, dividend reinvestment is the reinvestment of dividends into the company in the form of stocks or shares. As a shareholder, you can reinvest the dividend income in the same company or another company.

Pros and cons of dividend reinvestment

As previously discussed, dividend reinvestment can have both positive and negative consequences. Understanding these consequences is necessary before an investor decides to reinvest their dividend income.

Pros

Build wealth

Stocks and shares are capital that is reserved and can be converted to cash in case of future challenges. In case you do not have an immediate need for money, then reinvesting dividends is a perfect means to save at high returns compared to the bank savings. In case the company performs well during the year, the stock prices are likely to rise, and you can sell the shares at a profit.

Freedom to invest

Owning company shares gives you the freedom on time to invest and sell your shares. The stock market can offer the best opportunities to invest at certain times, and sometimes it may be expensive to invest in a stock. With the dividend income, you can choose to invest in company stocks when the share prices are low and then wait to reap the benefits when the shares increase. The flexibility gives you the appropriate avenue to make profits in stock trading.

No brokerage fees

First-time investment in company stocks may require guidance by stockbrokers unless you have adequate financial literacy. Dividend reinvestment will help you eliminate agency costs since you already have in-depth knowledge of the stock market.

Cons

Dividends are taxed

Dividend income, like major investments, is subject to taxation. Dividend incomes are usually taxed in many countries, and reinvesting your dividends exposes you to more taxes. If you are residing in a country where major government budgets are satisfied through taxes, dividend reinvestment makes you liable to more taxes. Another thing to understand is that the larger the dividend income, the larger the amount of tax to be paid despite the tax rate being constant.

Poor planning and financial literacy

Reinvestment in dividends requires a deep understanding of the financial market and company financial statements. To trade in stocks, you need to be capable of analyzing the company’s performance and understanding their future performance. Lack of financial knowledge or planning could lead you to reinvest in a company that may underperform in the future.

Limited control over stock shares

After reinvesting your dividends, you surrender the control of your finances and capital to third parties. Reinvesting leads to shareholder losing their control over their capital and the prices of market shares. The stocks’ prices are limited to the stock market, company performance, and economic factors, neither of which you can control.

Decision making on dividend reinvestment

Many people are always undecided about whether to reinvest their dividends or not. The decision to reinvest or not to reinvest should be guided by certain factors such as company current and future performance, economic factors like economic boom, recovery or recession, and the stock market performance. Consider these factors before making your bold moves.

Dividend reinvestment should be a decision based on company and economic factors and not instincts or influence. Building your wealth is more than dividend reinvestment. 

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