Dividend Reinvestment - A Bad Idea

By Jason Fittler

Dividend reinvestment is when a company gives you more shares in place of cash for your dividends. Not all companies provide a dividend investment plan. 

So should you use dividend re-investment or not?

My personal view is to never use dividend reinvestment plans, and here is why:

1. Even though you receive shares instead of cash you still need to pay tax on the dividend. It is a common mistake by investors to think that because they did not receive any cash that they do not have to declare it for tax. Wrong, you have received something of value, the franking credit will be attached and the amount of the dividend will need to be included in your tax return. The only problem is that, you did not receive the cash, so you will need to fund any tax out of other income.

2. The shares are issued normally at some volume average weighted price (VWAP) prior to the dividend being paid. This means that you do not get to choose the price at which you buy the shares, they simply get allocated a price by the company. For example, if your dividend was $1,000 and the VWAP was $15 per share then you get 66 shares rounded down for the decimal points. What you need to ask yourself is “would I buy more at this price?” If the answer is no, then why accept dividend reinvestment and pay too much. Sometimes the price is lower at which point why would you not just simply buy at market. Or is it the best buy on the market right now. The point is you should be making the decision of when to buy the shares, not the company.

3. Investors may think that they are saving fees or brokerage. This is true, but what fees will you incur because of dividend reinvesting:

a. Admin fees- you need buy a software program to collect and maintain the cost bases, date of purchase etc.

b. Opportunity costs – if you spend your time keeping track of the information yourself how much time will this take and what else could you be doing which would make you more money.

c. Accounting Fees – when you sell your shares, your accountant will take longer to input this information. As they work on hourly rates the fees for accounting work will increase. If you do not keep records, the cost to go back and get this information will outweigh and cost savings.

d. ATO – guess the cost base and therefore the capital gains. Best hope you do not get audited because unless you can prove the cost base the ATO will take the entire sale price as the capital gain.

Finally, you need to take a close look at any company, which provides dividend reinvestment, the issue is twofold:

1. Cash flow: Companies may be looking to maintain a certain dividend level, but their cash flow does not support it as such they simply issue more shares. A company whose cash flow does not support their dividend gets a red flag.

2. Dilution of your holding: By issuing more shares to pay for dividend reinvestment all shareholders shares are diluted. For example, if the company is worth $1,000 and has 1,000 shares worth $1 each and they issue another 100 shares as dividends. The company is still worth $1,000 but now there is 1,100 shares making each share worth $0.91. You have received nothing, but you will pay tax on it.