You collect cash from the dividends in your portfolio. But you don't need the cash. In fact, you'd rather just have more stock. So you apply a dividend reinvestment plan, wherein your dividends just go back to buy more stock, usually already-trading secondary stock from one of the brokerages that makes a market/trades in the stock you're buying, after you've set up an account with them. Or the function happens in the brokerage account in which you hold those divvy-bearing stocks.
The sad news is that your dividends will still get taxed, so you'll have to come up with cash to pay the tax, meaning that you actually lose cash each year, paying taxes on dividends you received which are taxable, and which then go back to buy more stock.
But if you're disciplined and don't need the cash, this can be a great way to goose long-term returns on your investments. By, yes...reinvesting.
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![Finance: What is Automatic Reinvestment?](https://media1.shmoop.com/video/thumbnails/COURSE.FINANCE.547_770x433.jpg)
Finance: What is Automatic Reinvestment?3 Views
Finance a la shmoop... what is automatic reinvestment? alright you bought an index
fund the focus companies whose names begin with the letter G, it's the G
indexer or G-index so like you know it's a whole lot of groupings of Google a
gaggle of GE, a glob of Gap, General Mills General Motors, Goldman Sachs you know [Lots of company logos]
through the Garmin the GPS people that's your index fund all G's while your
strategy and index picking may leave room for improvement while one element
you want to take advantage of is the provision for automatic reinvestment
that is for no incremental commission or fee instead of receiving your dividend
as cash and spending it on silly things like rent and gas and food you reinvest [Person receiving dividend]
your dividends and simply buy more shares of the G for good index fund the
effect over time is that your fund compounds at a much higher rate than it
would have had you just taken those cash distributions and run well how much
faster does it compound well if it was to grow at 6% a year without the
dividends reinvested and the dividends were about 3% a year then your total
return would have been 9% using you know advanced calculus there and remember
that rule of 72 thing well it takes an investment compounding at 6% that's 72 [Rule of 72 appears]
divided by 6 which means that the investment there will take about 12
years to double but in this case with dividends reinvested and we're gonna
ignore taxes here it's growing at 9% a year so it takes only 72 divided by 9
.....8 years to double with the
automatic reinvestment feature kicking in and 8 is better than 12 when it comes
to doubling your money in years that is and over time this is a really big deal [Man discussing automatic reinvestment]
like if you started with 10 grand in savings and just left it invested for 25
years well here's what it looked like note that you end up with almost double
your money when you automatically reinvest the money rather than take it
out as cash and also note you know our thing on taxes here if you have your
investment in a taxable account as opposed to an IRA or a 401 K which is taxdeferred [Taxable account and IRA/401k piles of cash appear]
that's how everything kind of plays out so the fund throws off lots of dividends
which you reinvest not only will you not be taking the cash from those dividends
but you'll have to pony up cash from some other source to pay the tax as you
go if you hold your index fund you know in a taxable account anyway if you don't
need the cash and have the discipline to just reinvest and well forget about it [Woman holding pile of cash]
you'll be a whole lot richer in the end game and that'll happen right about the
time you're too old to really enjoy it unfortunately youth is wasted on the [Kids sat on the grass talking]
young, you'll be too senile to regret it though so that's that's upside right...
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