Being paid just for owning a company’s shares sounds great, doesn’t it? And this is exactly why dividend investing is popular. One question that everyone following such a strategy faces, however, is what to do with this money. Here’s my take.
Dividends: made for spending?
Clearly, spending cash received from one’s investments will be a necessity for some. Those who are retired, for example, may need to use the extra income to boost their pension(s) and provide for a more comfortable standard of living. The bi-annual or quarterly cash payments can also be a source of comfort for those who are suffering from long-term health complications and perhaps are unable to work. Dividends can be a saviour during an unexpected period of unemployment as well.
And let’s not beat about the bush here: 2020 was a painful year for, well, everyone. The global pandemic served as a sober reminder that life is both fragile and finite. Having money provides security but it should still serve an instrumental purpose. It’s there to be used not admired, at least in my view. Having taken on the risk of owning stocks, some controlled spending can therefore be rationalised. A holiday here, a new (insert product of choice) there. Fair enough.
That said, I also believe in assessing what I might be sacrificing by spending what I receive. Call it FOMO, investing-style. For me, this changes everything.
Time is money
As a sprightly 40-something (OK, that first bit is an exaggeration), I’m hoping to stay in the markets for a good while yet. Knowing this, I’m aware that I stand to benefit the most from compounding — essentially, interest on interest — by keeping my money in the stock market.
There’s no need to get wrapped up in complex calculations here. The more shares of great dividend-paying companies I own, the more cash I receive (although this income is never guaranteed). The more cash I put back into buying great stocks, the more I ultimately benefit from compounding. Think of it as a snowball rolling downhill, gradually increasing in size.
This reasoning explains why I’ve not spent a single penny that’s been sent my way since I first opened a Stocks and Shares ISA many years ago. Instead, it’s either gone straight back into buying shares or temporarily held in preparation for the next correction or crash. By the way, I think we’re due one of the latter before too long.
As things stand, my stance is at one extreme. There’s no rule to say I can’t spend some of the cash and reinvest the rest. Indeed, this is probably what I’ll do as the years pass.
Have a plan
Whether dividends are spent, reinvested or a mixture of the two will depend on an investor’s personal situation — their financial goals, risk profile and time horizon.
My ‘arrangement’ works for me. It might not work for others, of course. Just as two people can reach different conclusions about the same stock, we can also disagree about what to do with the money it pays out. Importantly, neither of us will be wrong as long as we do what’s right for us as individual investors.
And isn’t having a plan for what to do with dividends far better than not having one at all?
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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.