ICLUB Therapist: Reinvesting Dividends?
By Doug Gerlach
Our club is trying to decide if we need to have a broker who will buy fractional shares when a company pays a dividend. Our present broker only pays cash. Some members feel strongly that we should not hold fractional shares in our account and others feel we should reinvest dividends. Do you have any guidelines for this?
- Marilynn S.
NAIC recommends that investors reinvest their earnings into the stock market. The idea behind this advice is to discourage you from constantly removing your investment "profits" and then splurging them on some unnecessary purchase, but to instead let the power of compounding work over the long term. Just as with the lessons about compound interest that you probably learned back in grade school, if you reinvest all of your earnings back into the stock market, those earnings will grow, and over time your investment returns will benefit. Over the course of 20 years, in fact, the effects of compounding will actually be responsible for the largest part of the growth seen in a stock portfolio.
This does not mean that dividends paid by individual companies must be automatically reinvested in those same companies, however. Some investors prefer to have their dividends reinvested automatically in the same shares, whether in a DRIP or direct stock purchase plan, or in a "synthetic" DRIP at a brokerage firm (sometimes at no charge, and sometimes with a small fee or commission). Automatic reinvestment allows investors to take advantage of the principles of dollar cost averaging, since those dividends buy more shares when the price is lower, and fewer shares when the price is higher. It also allows them to make sure that all of their available cash is always working in the stock market, instead of holding a few dollars of cash in your account that might not even cover the commission on a new purchase.
Other investors opt not to use automatic reinvestment. Dividend reinvestment plans often (but not always) cause you to own fractional shares. If the dividend that's paid isn't enough to cover the cost of a full share, you'll end up with a fractional share. These fractional shares can occasionally complicate your bookkeeping when the time comes to sell, since different commissions may apply to the sale of fractional shares.
As far as NAIC Club Accounting Software is concerned, it doesn't make any difference if you own 100.000 or 100.034 shares of a stock. The software handles the transaction just as easily either way, and it's just as easy to enter a "dividend reinvestment" transaction than it does to enter a "dividend paid" transaction.
Now, on to my diagnosis. In an investment club, you should be investing on a regular basis, with members contributing new capital each month. Any dividends paid by your stocks will simply go into your cash account, be added to the member's paid-in capital and be ready to be invested in your club's next purchase. As a result, automatically reinvesting your dividends isn't really necessary -- you'll be investing those dividends soon enough in some new or current holding. That satisfies NAIC's rule about reinvesting earnings.
Your club is divided on the issue, and that's natural – since it doesn't really matter one way or the other! There's not really any significant downside to holding fractional shares, so that shouldn't be a concern. The overriding decision point should be whether or not you're happy with your current brokerage in other matters. In my opinion, if you're satisfied, then you should stick with them and forget about automatic dividend reinvestment.
Doug Gerlach, author of several popular investing books and websites, serves in his spare time as
Secretary of NAIC's Computer Group Advisory Board. To ask Doug an investing
question yourself, just write to
How do you measure up. . .
. . .against the markets? Investor Advisory Service (IAS), a newsletter started by NAIC in 1974, has beaten the S&P 500 by an average of 9% per year over the past 5 years.
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They share not only their conclusions but also their logic in the monthly IAS newslwetter, available both online and in a printed version, which includes 3 detailed stock recommendations with SSGs filled out, updates and rankings on dozens of previously recommended stocks, analysis of market news, and more. Recent addtions to the Service include email updates between issues and Q&A with the experts in the newsletter.
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Club Notes: Understanding Unit Valuation
By Joe Pulizzi, ICLUBcentral
Want to totally confuse the new members in your club? Try talking to them about the unit valuation system. Truthfully, it's not a difficult concept, but it seems many investment club members cannot grasp it. Hopefully, this article will make some sense out of it.
Think Mutual Funds
Do you have any mutual funds? Do you ever check their price? When I first began investing, I could not understand how mutual funds could assign a dollar amount. I would ask, "How can you assign a number? They have hundreds of stocks, and none of the stock prices in the fund's portfolio seem to have anything to do with the mutual fund price." OK, those weren't my exact words, but it was something like that.
Mutual funds operate with something called Net Asset Value, or NAV. The NAV price is what it would cost you, the investor, to purchase one share of the mutual fund. For example, I own Fidelity Aggressive Growth. The current NAV for this mutual fund is around $13. It would cost me $13 to buy one share into the fund. When the stocks in Aggressive Growth go up, so does the NAV of the fund. If the stocks go down, the NAV goes down.
To read the rest of the story, go to
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