- Date : 07/04/2021
- Read: 6 mins
Learn about effective ways to reinvest dividends earn from your stock portfolio.
Ever heard of Grace Goner? Hailing from humble origins, she was hired as a secretary at Abbott Labs during the early 1930s. In 1935, she purchased three shares of the company, which cost her about USD 180. She continued to reinvest the dividends but never indulged in trading using any additional income. In 2010, when Grace passed away, her investment in Abbott was worth a whopping USD 7 million!
That is the impact of reinvesting dividends. Read on to learn more.
What is a dividend?
A company issues shares that are listed on the stock exchanges and traded daily. The returns earned by an individual from the stocks of a company is called a dividend. The profits earned by the company after paying the creditors, preference shareholders, and other liabilities appearing on the balance sheet, are distributed among shareholders in the form of a dividend. Giving dividend payment as a return is not mandatory, however. Between April 2020 and September 2020, more than 600 companies in India announced dividends worth Rs 49,674 crore.
Reinvesting dividends
There are certain individual investors as well as families that have been investing for decades and therefore receive dividends running to lakhs or crores of rupees. But these are likely to be outliers or exceptions. Typical dividend yields offered by listed Indian companies are in the range of 1% to 4%. Average dividend yields from BSE Sensex and BSE Index are around 1.5%. So, on an invested capital of Rs 5 lakh, one can expect a dividend of Rs 7500 per year. Although this isn’t pocket change, it isn’t a lot of money either.
Yet, investors seek to put this money to good use and are keen to reinvest their dividends. Let us check out some options for such investors.
|
Reinvestment option |
Important points to consider |
|
Public provident fund (PPF) |
Low risk, long term, achieves gains |
|
Fixed deposits |
Low risk, short to medium term, one can park funds to gain decent interest (quarterly, half-yearly, or yearly) |
|
Mutual funds |
Many options to consider in line with one's investment horizon, risk appetite, and objectives |
|
Stocks (accumulation or drip strategy) |
High risk, long term, creates wealth |
Related: How is dividend income taxed?
Public provident fund (PPF)
One can deposit a minimum of Rs 500 in a PPF scheme. Hence, it might be convenient to invest dividends in a PPF. There are multiple benefits of investing in PPF, such as:
- Your invested capital is protected
- You can enjoy a compound interest of 7.1%
- You’re eligible for tax exemption upto Rs 1.5 lakh under Section 80C of the IT Act
The maturity date of your PPF investment is considered to be 15 years from the end of the financial year in which your deposit was opened. So, if you hate risk, have a long-time horizon, and can invest your dividends every year, you could opt for a PPF.
Fixed deposit
Depending on your time horizon and the dividend amount at hand, you can open a fixed deposit. This too offers steady returns and protects your capital. An FD is highly recommended for those who aren’t sure about where to invest their dividend earnings. Those who need some cash in the short term can explore this method. The minimum amount to open an FD ranges from Rs 1000 to Rs 10,000, depending on the bank. Look at these FAQs about fixed deposits.
Related: FD returns vs inflation: Here's how you can keep your purchasing power intact
Mutual funds
Certain mutual funds allow investors to start with as little as Rs 100. If you have a mid- to long-term investment horizon and a healthy risk appetite, you could either invest the dividend earnings as a lump sum amount or start an SIP. You can consider equity funds, debt funds, hybrid funds, index funds etc.
Those with long-term investment horizons and higher risk appetites could consider equity funds. Investors with a lower proclivity to risk and long-term investment horizons could explore index funds. Ultra-liquid or liquid funds would be suitable to park your dividend earnings for the short term at low risk.
Related: Different types of funds available under mutual funds
Stocks
To reinvest dividends in stocks, investors can use one of two strategies:
- Accumulation strategy: Through this, investors can let the dividends accumulate. The dividend earnings can be parked in an ultra-liquid fund or a savings account. When the market falls, this corpus can be used to buy fundamentally strong stocks at mouth-watering prices.
- DRIP strategy: DRIP stands for dividend reinvestment plan. As the term implies, it can be used by investors to reinvest their dividend earnings in stocks. Cash dividends earned by an investor can be either reinvested in the same stocks or in other strong stocks. Over time, this strategy enables an investor to create a robust portfolio.
Related: What are stock SIPs?
Last words
Investors can consider a variety of strategies if they wish to reinvest their dividend income. It is highly recommended that they also take the advice of a credible personal financial planner before making such decisions. On a parting note, when Grace passed away, she bequeathed her entire holdings to her alma mater (Lake Forest College) to be used as scholarships. Capital gains vs. dividend income: What's the difference?
