What Should I Do With My Dividend Payments?

Dividends are the rewards for your investment in a company's shares. However, what you do with it when received can determine whether you grow in your wealth journey or retrogress

There are two kinds of investors in Nigeria. Let’s call them Tosin and Bayo. Both are in their mid-thirties, leading relatively simple lives with minimal dependents, and having consistent streams of income.

Tosin and Bayo employ conservative methods of investing, often opting for treasury bills and relatively safe mutual funds. In 2011, they invested in a mutual fund with a stable interest yield of 12% annually, but that’s as far as their similarities go.

When Tosin gets his interest every year, he makes a withdrawal and parties lavishly with his friends. Afterall, it is additional income and does not affect his investment capital. However, when Bayo gets his interest, he reinvests it because he doesn’t depend on the dividend earned for survival.

Six years later, Tosin is now called the life of the party but is worth exactly what he was worth six years ago as every time his investment capital multiplies, he eats the profit and repeats the same cycle all over again. Bayo, on the other hand, has doubled his initial investment capital without changing his lifestyle one bit.

Which one of them are you?

So, maybe this scenario is too ideal. In fact, if you’re saying that it doesn’t exactly work this way in the stock market, you’re not wrong. For starts, nobody can promise you stable dividends. However, the results are not far apart.

While there are indeed uncertainties that come with rising and falling stock prices, in the long run, reinvesting is a much better option than making withdrawals and here are some of the key reasons why:

1. Stock Price Averaging: A major reason people don’t want to reinvest their dividend payments is because of the changes in stock prices. However, when you invest for long term gains, the benefits become exponential. When you re-invest, you spread your investments across periods.

This could be multiple times a year depending on how frequent the company pays its dividends. As such, you are not spending money at once buying any particular stock at an unfavorable price. Rather, you are making purchases are different periods harnessing the benefits and ultimately leading to a balance in stock prices.

2. Offset Higher and Lower Dividends: Following closely from point 1, another wonderful reason you should reinvest your dividend payments is that you get to offset low dividend payouts with high ones. On the Yochaa app, there is a dividend heat map under the explore tab that shows dividends paid by all listed NSE companies and it allows you monitor the trend in dividends paid by various companies. When you view any stock, you can assess the dividend paid over the past 5 years and see what it averages out as.

For example, let’s say you have shares in Zenith Bank. In 2014, dividend yield was 8.40%; in 2015, it rose to 13.80%; in 2016, it dropped slightly to 12.16%; it was 8.74% in 2017 and in 2018 it was 12.50%. On average, the dividend yield for the last 5 years was 11.12% which is higher than its rates paid in 2014 and 2017.

So, if you had withdrawn your investment in 2014, you would have had less to gain not just during years with higher yields but also on average.

Also, while your dividends are taxable whether you reinvest or not as long as it is in a taxable account, you might be able to skip the hassle of paying commissions to brokers. This is a popular advantage when investing in foreign shares.

However, this is largely an unpopular opinion in Nigeria. Consult your broker to determine if you would need to pay additional commission on your reinvested dividend payments.

These being said, it is important to note the following:

If you rely on your dividend stocks to generate income, cashing out becomes the only choice you have. The rule of thumb with investing in stocks is investing what you can do without at least for a given period of time.

Also note that whenever you are making a purchase, you should consider its outlook not just at the time of purchase but also in the future. For example, if it has become public notice that a company would soon go bankrupt or might be involved in some political issue, it would be safe to watch the waters for a while before ploughing your dividends back in.

Finally, reinvesting your dividends into the same stock would mean that you purchase more of a specific stock. The risk of this is that the diversification of your portfolio might be reduced, thus increasing your risk.

Thus, it is important that you view your investment not focusing on a specific investment vehicle but on your entire investment portfolio. You can use the Yochaa app to monitor your portfolio and see if you are not getting too heavy on a particular stock.

A key attribute of a successful investor is his ability to delay gratification. Reinvesting gives you the keys to building sustainable wealth and increasing your net worth over time.

Article by Lawretta Egba