Question about dividend re-investment strategy

Submitted by BrandonQuinnDixon t3_zzzo10 in personalfinance

I'm new to investing, I've been doing so for roughly half a year. My goal is to invest in stocks that pay dividends and continuously re-invest those dividends back into more shares over the roughly 30 stocks I have shares in. I've created a strategy which I believe will let me increase my dividends slightly faster but I'd like to share here and confirm.

Every 2 weeks, I make my investments, combining a fixed amount from my paycheck with whatever dividends I've received in the previous 2 weeks. My strategy is to heavily favor buying shares in stocks where the ex-date will occur within the next 2 weeks. My reasoning is that I will see a slight return from that investment pretty soon in the form of dividends paid out by that stock within the next month or so. As I keep doing this, I'll be compounding dividends faster.

I believe this is valid because of this thought experiment: let's say I have 4 stocks which pay once per year. Each stock pays dividends in a different quarter: stock A for Q1 up to stock D for Q4. Each pays 4% dividend. I'll have $100 each quarter to invest.

  • If I invest $100 in each quarter all into stock D, I'll have $400 in stock D and have a total value of $416.
  • If I invest $100 in each stock at each quarter, I'll have:
    • $100 in A, which yields $4
    • $104 in B, which yields $4.16
    • $108.16 in C, which yields $4.3264 (I'm not sure how the rounding would actually work but here I'll use fractional cents)
    • $112.4864 in D, which yields $4.499456
    • At the end, I'll have a total value of $100 + $104 + $108.16 + $112.4864 + $4.499456 = $429.15

My question here is, does this logic carry over into the real world, and are there any drawbacks which I'm not aware of.

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nothlit t1_j2ejmwr wrote

The mistake you made is thinking dividends behave like interest. They don’t. Dividends aren’t free money. A $100 stock that pays a $4 dividend is immediately worth $96, so you still only have $100.

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BrandonQuinnDixon OP t1_j2ejux1 wrote

I'm not sure I follow. If I buy the stock for $100, wait for the dividend of $4, then at that time, sell it for $100 (assuming it's still that price, could be higher or lower), I'll end up with $104 in cash.

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nothlit t1_j2ekaie wrote

There is no guarantee the stock will be worth $100 after the dividend is paid. In fact, it is far more likely to be worth $96.

https://www.fidelity.com/learning-center/investment-products/stocks/why-dividends-matter

> A stock price adjusts downward when a dividend is paid. The adjustment may not be easily observed amidst the daily price fluctuations of a typical stock, but the adjustment does happen.

> …

> This downward adjustment in the stock price takes place on the ex-dividend date. Typically, the ex-dividend date is 1 business day prior to the record date. The ex-dividend date represents the cut-off point for receiving the dividend. You have to own a stock prior to the ex-dividend date in order to receive the next dividend payment. If you buy a stock on or after the ex-dividend date, you are not entitled to the next paid dividend. If this sounds unfair, remember that the stock price adjusts downward to reflect the dividend payment. Therefore, while you are not entitled to the dividend if you buy on or after the ex-dividend date, you are paying a lower price for the shares.

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BrandonQuinnDixon OP t1_j2ekzm8 wrote

I see, that's good to know. So it sounds like when the dividend is paid out, stock price falls accordingly to the total amount paid and thus the amount of money that has left the company, then the stock price rises slowly as the company replenishes those funds throughout the quarter?

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nkyguy1988 t1_j2elo5n wrote

That's right. On the ex date, the share price is literally reduced by the amount of the dividend. It's hard to see as prices move in real time. If on ex date you have a single 100$ share and it pays a 5$ dividend, you will then have a share worth 95$, if even for a moment, and 5$ cash, which you can then use to reinvest.

If the stock goes up. No guarantee it will.

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BrandonQuinnDixon OP t1_j2en1c8 wrote

In that case, I'll have to re-evaluate my reasoning. I think the base of it still holds, but now if I buy stock right before the ex date, I'll be buying it at local maxima point. On the other hand, if I buy it right after the payout, it will be lower, but then I won't see any return for more time.

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DeluxeXL t1_j2enh30 wrote

> then I won't see any return for more time.

You will see return, just not "forcibly realized return".

Dividend distribution is a forced taxable income, whether you want it or not, whether you are in 15% tax rate or worse.

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nkyguy1988 t1_j2enyum wrote

Yield is yield. A 10% growth, no dividend yield is the same as a 3% dividend and 7% growth. Plus, the added benefit of not being forced into a taxable event, if within a taxable account.

You never want to "buy the dividend" it's a net zero and taxable, again if within a taxable account.

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Citryphus t1_j2eopa8 wrote

If you plan to hold the stocks long term in a taxable account, you should prefer to buy on/after the ex-dividend date.

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YeahIGotNuthin t1_j2eyhwb wrote

I think the point they are trying to make is that two equivalent companies with shares currently worth $100, one paying a 4% dividend and one not paying any dividend, with both experiencing a 5% profit growth over the year, the dividend-paying company would pay you $4 over the course of a year and be worth $101 per share at the end of the year, while the other company would be worth $105 a share.

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geli7 t1_j2eoo66 wrote

Don't overthink it. Every broker has stock screener and you can look for stocks that have historically paid dividends. Within that bucket, look for stocks you like. The quality of the company you're buying is more important than the dividend.

Start the screen with dividend paying stocks, find companies you like within that category, buy then and set your account to reinvest dividends. Done.

Alternatively, there are plenty of funds that specialize in dividend paying stocks and do this for you.

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