If you are a regular reader of finance articles, you probably know that one topic which many writers beat to death with a brickbat is the strategy regarding dividend reinvestment. Generally, there are two camps: one argues for the reinvestment of dividends back into the company that pays them, and the other side favors the accumulation of dividends into a general pile until it becomes sizable enough to fund a new investment in its own right (and in the early stages, usually this is accompanies by the infusion of fresh cash from your labor as well).

The rationale behind reinvesting back into the same company is that it is easy, automatic, free (you have the wrong broker if it costs you anything), and permits an investor to see his holding size increase without any additional effort whatsoever on his part.

The rationale behind pooling investments together is this: when we purchase a stock, we are trying to find the perfect calibration between a company we want to own and the price at which we’d like to own it. Anytime we make an investment, we are essentially saying, “This is the most intelligent thing I can do with my money right now.” Although the generation of dividends is a passive pursuit (unlike earning a paycheck which requires that you put in the time), there is no rational basis for treating dividends as income unworthy of deliberate allocation. And if you aren’t willing to make a “full investment” into a company at a given price, why would you want to put your dividends there when there is something more attractive out there?

The fun thing about investing is that there are no restrictions—it’s our money, and we’re the boss. We can be free to reject the notion that everything has to be constructed into “either/or” format, and I’ve found great contentment taking a “pooling approach” as well as an automatic reinvestment approach.

Let me explain my personal rationale: for most stocks, let’s say around 75% of a portfolio, I think it makes sense to pool the dividends together. Taking a dividend from Pfizer, a dividend from from Walgreens, and a dividend from Microsoft to combine with your fresh cash and make a new investment into a company like BP seems like a perfectly intelligent way to go about life. And plus, it is fun. You always have new money coming in (some of which required no physical labor on your behalf), and you get to add an ownership stake to your portfolio on a fairly regular basis. That’s when income investing becomes enjoyable—you have income coming in to make new investments, which will in turn generate income, so you will have even more money coming in down the road. That’s the cycle you’re trying to get going in your life.

With that said, I think the other 25% of the portfolio makes sense to engage in an automatic reinvestment program with the absolute highest quality companies in your portfolio. I’m talking about automatically reinvesting into Johnson & Johnson, Coca-Cola, Exxon-Mobil, Procter & Gamble, Exxon-Mobil, and a few others. The rationale for doing this is a hat tip to the earnings quality of these dividend-paying blue chips. You know Coca-Cola is going to be around and pumping out profits in twenty years. You know Johnson & Johnson is going to be around and generating some nice cash income for shareholders fifteen years from now. And better yet, there is a good chance they will grow 10-12% annually between now and then (or, at the very least, they are at the top of the list of companies where you can make those kinds of predictions). Why wouldn’t you want to see your position in those five companies automatically increase with each passing year? These companies are the best of the best, and it should be a joy to watch them grow along with you.

That is something that brings me joy and excitement. Every time you go to a grocery store in see someone buy Coca-Cola, or go to a restaurant and see someone drink Diet Coke, or go to a high school basketball game and see the kids drink Powerade, you could know that, every ninety days, you are increasing your ownership in the company that produces those drinks along with 497 others. The purpose of reinvesting into these companies is to recognize that they are the badass companies of capitalism, and you are going to increase your ownership in them. Why not execute a blended strategy that pools money for new investments while simultaneously allowing you to automatically increase your position sizes in the best companies this world offers?

Originally posted 2013-07-20 07:42:03.

Like this general content? Join The Conservative Income Investor on Patreon for discussion of specific stocks!