Strategies for Reinvesting Dividends Earned from ETFs

Reinvesting dividends from mutual funds is straightforward, but when it comes to exchange-traded funds (ETFs), the process can be a bit more complex. Dividends earned from ETFs can be reinvested manually by purchasing additional shares with the dividend payments or automatically through dividend reinvestment plans (DRIPs).

While not all ETFs offer automatic dividend reinvestment plans directly from the fund sponsor, most brokerages allow investors to set up DRIPs for any ETF that pays dividends. This option is increasingly available for virtually all ETFs and can be a smart choice due to the longer settlement times associated with ETFs and the inefficiency of manual reinvestment in a market-based environment.

Dividend Reinvestment Plans (DRIPs)

DRIPs offered by funds or brokerages enable investors to automatically reinvest dividends to purchase additional shares of the security, providing a convenient way to grow investments effortlessly.

DRIPs offer ease and efficiency for ETF shareholders, streamlining the reinvestment process, especially with the prevalence of fractional shares. Unlike in the past, where variables in programs caused issues, today, dividends are typically fully reinvested upon issuance, even if it is a fraction of a share.

One drawback of automatic ETF dividend reinvestment is the lack of control over market timing. However, for long-term investors with a buy-and-hold strategy, this is often a minor concern.

Manual Reinvestment

If your brokerage does not offer a DRIP option or your ETFs do not allow automatic reinvestment, manual reinvestment is a viable alternative. This involves using the cash from dividend payments to execute additional trades and purchase more shares of the ETF, offering investors greater control over their investments.

Major online brokerages now provide commission-free dividend reinvestment services to investors.

Manual reinvestment, while less convenient than DRIPs, allows investors to have more control over the timing of their investments and the flexibility to reinvest dividends into different securities if desired.

It is important to be aware of settlement delays with ETF dividends, as they can impact the purchasing power of dividends, given the longer settlement times compared to mutual funds.

Do ETFs Pay Dividends?

If the holdings in an ETF’s portfolio pay dividends, these dividends are also payable to ETF shareholders. While some ETFs distribute dividends as received, most collect and distribute them quarterly.

Why Should I Reinvest ETF Dividends?

Reinvesting ETF dividends can compound returns over time and enhance dividend income, providing a growth strategy for investors unless they require the cash for income purposes.

Are ETF Dividend Reinvestments Taxed?

Yes, ETF dividend reinvestments are taxed similarly to cash dividends and must be reported on tax returns according to the IRS.

Why Are DRIPs Preferred to Manual Reinvestment with ETFs?

DRIPs help eliminate timing issues associated with reinvesting ETF dividends, provide ease of use, and ensure continuous reinvestment without the risk of forgetting or missing the opportunity manually.

The Bottom Line

Reinvesting ETF dividends is a simple way to grow your portfolio. Utilize DRIP plans available through ETF providers and brokers for a convenient and efficient reinvestment process. Be mindful of settlement periods to optimize your reinvestment strategy and actively manage your trades if opting for manual reinvestment.