When you purchase shares in a company that pays a dividend you have the choice of how you would like to receive your dividend. You have two options, the first of which is to accept the dividend as a cash payment and the second is to accept the dividend in the form of additional shares in the company stock. These additional shares can be either whole or fractional depending on the value of the dividend used to purchase them. Once you have the dividend keep in mind that it will be taxed no matter which way you choose to receive it. When buying dividend stocks through a brokerage, usually you’ll receive the dividend as cash unless you specify otherwise.
Receiving a cash dividend can help you meet your personal needs in retirement and is often a good supplement to a paycheck that can be paired with additional retirement savings. Dividends are a good supplement not only because of their reoccurring nature of being payed out quarterly or monthly but also because of dividend increases over time. A well run company with solid earnings, free cash flow and low debt that pays a dividend is more likely to increase that dividend on a regular basis which can act like a yearly raise you might expect when you work for a company. The dividend increases can help to keep pace with or even push ahead of inflation.
Investing for the long term in this post will be considered ten or more years. The earlier you start the investment process the more compounding can take place. For example let’s say you purchase 10,000 shares of a dividend stock at $45.00 per share and keep it for twenty years. In this example you now own shares of stock worth $450,000.00. Let’s further say that the dividend stock you’ve invested in pays a 2.5% dividend yield paid quarterly. Let’s also assume that this dividend increases by 5% per year. The first year’s dividend comes to $11,572.65 which would buy 217.17 additional shares of stock. By year twenty the dividend value increases to $65,935.24 of additional company stock. Looking at the total shares of stock assuming the price the same as it was on year one the total value with reinvested dividends is now worth $1,048,525.33. This number does not factor in the change in stock prices over the long term and as such in a quality company should be much higher possibly by 2 times or more.
In order to reinvest your dividends you can either sign up for a dividend reinvestment plan (DRIP) with the company that you are buying stock in or you can purchase the company stock through a brokerage company and specify to the brokerage company that you would like to reinvest your dividends in the stock you’ve purchased thereby increasing your shares of stock in the company you’ve invested in over time. This can be done usually at a low or at no cost to you through your brokerage.
It’s a good practice in the long term to reinvest your dividends for several decades and then when you get ready to retire move a percentage of your dividend reinvestment to cash so that you can start to pay your personal expenses with it. As time goes on not only will you have a dividend cash income stream but part of your dividends can remain reinvested, growing your dividends and your future income.