Mutual funds have made dividend reinvestment easy but reinvesting dividends earned from exchange-traded funds (ETFs) can be slightly more complicated. Dividend reinvestment can be done manually, by purchasing additional shares with the cash received from dividend payments, or automatically if the ETF allows.
Automatic dividend reinvestment plans (DRIPs) directly from the fund sponsor aren't yet available on all ETFs although most brokerages will allow you to set up a DRIP for any ETF that pays dividends. This can be a smart idea because there's often a longer settlement time required by ETFs. Their market-based trading can make manual dividend reinvestment inefficient.
Key Takeaways
Dividend reinvesting can be done via dividend reinvestment plans (DRIPs) or manually.
Most mutual funds offer DRIPs but dividend reinvesting for some ETFs still must be done manually.
A disadvantage to automatic dividend refinements for ETFs is that investors lose the ability to time the market.
Manual dividend reinvestment is less convenient but it provides more control.
Dividend Reinvestment Plans (DRIPs)
An automatic DRIP is a program-offered fund or brokerage firm that allows investors to have their dividends automatically used to purchase additional shares of the issuing security. This practice has been widely used in stock and mutual fund investments but it's relatively new to ETFs.
DRIPs offer greater convenience and a handy way to grow your investments effortlessly but they can present some issues for ETF shareholders because of the variability in programs. Some brokerage firms offer automatic dividend reinvestment but they only allow the purchase of full shares. Any amount that's left over is deposited as cash into the investor’s brokerage account and this may be easily forgotten. Other firms pool dividends and only reinvest dividends monthly or quarterly.
Some reinvest dividends at market opening on the payable date. Others wait until the cash is deposited, which is typically later in the day. ETFs trade like stocks and their market prices can fluctuate throughout the day so a reinvestment executed at 7:00 a.m. may buy a different number of shares than a trade that's executed at 10:00 a.m.
This is one of the drawbacks of automatic ETF dividend reinvestment. The investor loses control of the trade and can't “time” the market to their advantage.
Manual Reinvestment
You can still reinvest dividends manually if your brokerage firm doesn't provide a DRIP option or if the ETFs in which you are invested don't allow for automatic reinvestment. Manual reinvestment means taking the cash earned from a dividend payment and executing an additional trade to buy more shares of the ETF. You may incur a commission charge for these trades, just like you would with any other trades, depending on where you hold your investment account.
Some brokerage firms allow for commission-free dividend reinvestments.
Manual dividend reinvestment is less convenient than a DRIP but it provides the investor with greater control. You can elect to wait if you feel that the share price may drop rather than simply pay the market price for new shares on the payment date. It also offers the option of holding your dividends in cash if you feel that the ETF is underperforming and you want to invest elsewhere.
More ETF options are available in 2024 and this might broaden your reinvestment possibilities if you handle the process yourself. The U.S. Securities and Exchange Commission has approved 11 spot market bitcoin ETFs to be listed on some exchanges as of Jan. 11.
Be Prepared for Delays
Be aware of the effect of settlement delays on the buying power of your dividends if you elect to manually reinvest your ETF dividends. Unlike mutual funds, ETFs rely on brokerages to keep track of their shareholders so dividend payments typically take longer to settle. Rather than the one-day settlement period of most mutual funds, ETF payments can take up to two days plus the trading day to settle.
The additional wait time can mean that you end up paying more per share if your ETF is doing well.
Do ETFs Pay Dividends?
If the shares or other holdings in an ETF’s portfolio pay dividends then they're also payable to shareholders of the ETF. A few ETFs will pay dividends as soon as they're received from each stock held in the fund but the majority collect those dividends and distribute them every quarter.
Why Should I Reinvest ETF Dividends?
Unless you need the cash flows generated from dividends for income, reinvesting those proceeds to buy more ETF shares can compound returns over time and lead to even greater dividend income down the road.
Are ETF Dividend Reinvestments Taxed?
Yes. The Internal Revenue Service (IRS) treats dividends that are reinvested the same as if they were received as cash. They must be reported on your tax returns.
Why Are DRIPs Preferred to Manual Reinvestment with ETFs?
A DRIP helps to eliminate problems with timing the reinvestment of ETF dividends. Unlike shares of stock that have a transfer agent and custodian tracking all shareholders of record for dividend purposes, ETFs rely on investors’ brokerages to track this. There can also be delays in when ETF dividends are distributed and when they hit an investor’s account, making manual timing more difficult.
The Bottom Line
Reinvesting your ETF dividends is one of the easiest ways to grow your portfolio but the structure and trading practices of ETFs mean that reinvesting may not be as simple as reinvesting mutual fund dividends. Consult your brokerage firm to see which of your ETFs are eligible for DRIPs and how the brokerage handles these trades.
Keep track of settlement periods to ensure that you don't poorly time your reinvestment if you must manually reinvest. Setting a market order for the moment when your dividend is deposited may not get you the best price per share so use manual reinvestment to your advantage by actively managing your trades.
A dividend reinvestment plan (DRIP) is a program that allows investors to reinvest their cash dividends into additional shares or fractional shares of the underlying stock on the dividend payment date.
easy but reinvesting dividends earned from exchange-traded funds (ETFs) can be slightly more complicated. Dividend reinvestment can be done manually, by purchasing additional shares with the cash received from dividend payments, or automatically if the ETF allows.
Investors can usually enroll in an automatic dividend reinvestment program through their brokerage account. They should be able to find this feature in their account settings menu. Once it's selected, investors usually have the following options: Automatically enroll all current and future stocks and funds.
The IRS considers any dividends you receive as taxable income, whether you reinvest them or not. When you reinvest dividends, for tax purposes you are essentially receiving the dividend and then using it to purchase more shares.
An ETF owns and manages a portfolio of assets. If those assets pay dividends or interest, the ETF distributes those payments to the ETF shareholders. Those distributions can take the form of reinvestments or cash. ETFs that position themselves as dividend funds generally opt for cash distributions over reinvestments.
When you buy shares of a security, you'll be asked whether you want any dividends transferred to your settlement fund or reinvested in more shares. Select Reinvest to buy additional shares.
Mutual funds have made dividend reinvestment easy but reinvesting dividends earned from exchange-traded funds (ETFs) can be slightly more complicated. Dividend reinvestment can be done manually, by purchasing additional shares with the cash received from dividend payments, or automatically if the ETF allows.
By reinvesting your dividends, you miss out on cash you could spend, save, or invest elsewhere. You might still owe taxes. Dividends are taxed whether you take a cash payout or reinvest them. However, with no cash payout, you have to pay the tax bill out of pocket.
Options include owning dividend-paying stocks in a tax-advantaged retirement account or 529 plan. You can also avoid paying capital gains tax altogether on certain dividend-paying stocks if your income is low enough. A financial advisor can help you employ dividend investing in your portfolio.
It May Take Longer To Achieve Long-Term Financial Goals: Dividend reinvestment leads to compounded growth. This makes it easier (and faster) to achieve your long-term financial goals versus keeping cash in a savings account.
So what does it mean to live off your dividends? If you invest in dividend-paying stocks, mutual funds, or ETFs, which provide distributions of stocks or cash to shareholders, over time, the cash generated by those dividend payments can supplement your income when you retire.
Moreover, the investor must own the shares in the ETF paying the dividend for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. This means if you actively trade ETFs, you probably can't meet this holding requirement.
A DRIP automatically reinvests dividends to purchase additional shares of a security. With a DRIP, an investor's cash dividends and capital gains distributions are reinvested into their account automatically, helping them accumulate more shares of the same stock, at no charge.
An accumulating ETF directly reinvests the dividends into the fund for you. This means that the value of an accumulating ETF will increase faster than its distributing counterpart. So even though you don't get a dividend payout in cash, you still benefit from the dividends.
This no-fee, no-commission reinvestment program allows you to reinvest dividend and/or capital gains distributions from any or all eligible stocks, closed-end mutual funds, exchange-traded funds (ETFs), FundAccess® funds, or Vanguard mutual funds in your Vanguard Brokerage Account in additional shares of the same ...
If the company pays out cash dividends, you will owe taxes on those payments even if you decide to reinvest the cash received. If however, the company reinvests your dividends to purchase additional shares, you will not owe taxes until you sell those shares.
By taking dividends in cash instead of reinvesting them, you can diversify into other assets, rather than adding to a position that you already have. It throws your portfolio out of balance. Higher-yielding, faster-growing securities have a way of building up far quicker than other assets do.
The Total Real Returns chart demonstrates this more clearly than conventional (nominal-dollar, price-only) stock charts, because: we include the effects of inflation-diminished purchasing power, and. we include the effects of reinvesting dividends from the initial investment.
When dividends are reinvested on your behalf and used to purchase additional shares or fractions of shares for you: If the reinvested dividends buy shares at a price equal to their fair market value (FMV), you must report the dividends as income along with any other ordinary dividends.
Introduction: My name is Melvina Ondricka, I am a helpful, fancy, friendly, innocent, outstanding, courageous, thoughtful person who loves writing and wants to share my knowledge and understanding with you.
We notice you're using an ad blocker
Without advertising income, we can't keep making this site awesome for you.
