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The Pros and Cons of Dividend Reinvestment

|Includes: Realty Income Corporation (O)


Let me start out by saying that the market currently has me as nervous as a long-tailed cat in a room full of rocking chairs. Since I’m not yet retired, nor have any imminent plans to do so, my holdings are set for automatic reinvestment of dividends. But as the market has continued to climb, many of my holdings are, in my opinion, fully valued. One holding, Realty Income, is arguably even somewhat overvalued.


One of the benefits to reinvesting dividends is that it allows an investor to put at least one aspect of managing a portfolio on autopilot, so to speak. Conventional wisdom suggests that, given the long term trend for equities to go up in price, reinvesting dividends results in de facto dollar cost averaging. At a high share price, a dollar of dividends buys fewer shares, and vice versa.


Now, however, I find myself wondering if, in keeping all of my positions set to reinvest, I’m not making the mistake of “buying high”. I’m not suggesting “flipping” from reinvestment to taking dividends in cash to attempt to take advantage of a relatively short-lived 5-10% correction, and then back again. While I suppose that sort of timing is at least theoretically possible, the amount of work (and/or luck) needed would hardly be worth the effort.


On the other hand, if an investor feels that a longer term erosion in stock prices lays ahead, for whatever reason, it would make sense to start letting dividends accumulate as cash for deployment at more reasonable valuations to open new positions, to augment current ones, or some combination of both.


Like many, if not most investors, I keep a watch list of stocks, and normally, when I exit a position, or take some money off of the table and do some trimming of a position, I already know where that cash will be deployed. At present, however, just about everything on my list is also at least fairly valued, so it makes little sense to trade one fully valued position for another. One downside to switching over to accumulating cash is the fact that the current return is laughingly miniscule. Going back to the example I mentioned earlier, Realty Income is paying 4.87%. That’s certainly a far cry from the 6+% it paid earlier in the year, but compare 4.87% to what the average money market fund pays!


In summation, under current market conditions, I’m becoming increasingly of the mind that it might be wiser to be taking the cash.

Disclosure: Long: O