Dividend reinvestment is a fantastic way to unlock the power to be had in compounding. Indeed, it’s tempting to want to spend some of the dividends and distributions coming in. However, those focused on growth shouldn’t seek to spend a penny of dividends if they can help it.
Indeed, why take a bit of momentum out of a freight train that’s already on track and going at full speed? In any case, one big question that younger, growth-minded investors may have is whether it’s better to just go for the growth stocks that don’t pay a dividend (or have a very small dividend, typically under 0.5%), or a higher-yielder with the intent of leveraging DRIP.
Keeping things simple with growth plays can make sense for most. However, it’s the higher-yielders that tend to exhibit far less in the way of volatility, especially if we’re talking about the names that tend to sport yields well above 4% by design. Of course, more income paid out means less capital to be invested towards growth.
And with distributions being paid out, it’s going to be the investors who will have to pay the tax bill. Add the added costs of implementing a DRIP into the equation, and it seems like a no-dividend growth strategy makes more sense than DRIP with high-income plays, especially those dividend stocks that are more volatile than the market.
So, why even both with dividend plays if one is just going to reinvest the cash that flows into one’s trading account?
The path of less volatility and more income!
Passive income from higher-yielders can help reduce volatility, even if the beta on the shares themselves is above 1.0. Indeed, if you’re getting 7% or more from a stock, much of the choppy moves in the shares will be made somewhat smoother by the monthly (or quarterly) dividend payments. Indeed, the passive income flowing in is not considered in the beta of a stock or ETF.
Either way, in sluggish, consolidating, or even bear markets, having a steady income coming in can really help one stay on the high road, even as trends change and sentiment shifts. Additionally, dividends play such a huge role in total returns over extended periods of time. Historically, dividends move the needle, and they matter just as much, if not more, than capital gains, especially during periods when the market has an off year or a couple in the red.
Another benefit is the optionality to reinvest in any given month. Perhaps one will actually need to spend the income coming in due to unforeseen financial circumstances (think a layoff or a financial emergency), rather than plowing that cash back into one’s investments. It’s never fun to think about what can go wrong, but with ample dividends flowing in, one can always hit the pause button on DRIP as they look to get back up on their two feet.
DRIP and low-volatility may be an outperforming strategy when the bull runs out of steam. Just be mindful of fees and taxes!
When it comes to this individual whom I came across on Reddit, they’re looking at harnessing the power of DRIP with their IV income ETF strategy. Undoubtedly, such high-income offerings, which may dampen the downside in particularly volatile markets, could be worth considering, especially for those who are concerned that an AI bubble is brewing.
While I do think the strategy could leave them trailing the rest of the market if the AI tech bull run continues for another couple of years, I do think that the peace of mind provided is difficult to replace, especially for those who believe that market valuations are extended, potentially limiting capital gains potential in the next five to eight years.
Either way, combining DRIP with an income-volatility strategy seems smart, provided one is using a tax-advantaged account and DRIP won’t cost all too much in added fees. Indeed, it’s not a strategy for everyone, but one that could make sense in this pricey, heated environment, where much of the future gains may have been pulled forward due to hype surrounding AI and its impact on corporate earnings.
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