There is no doubt dividend re-investment is an attractive option to many shareholders as it provides the benefit of a small discount and substantially reduced brokerage.
Any purchasing of share assets should depend on the outlook of the particular share at the time of purchase. Sometimes you may hold a tranche of shares that are good quality but buying into them indiscriminately at distribution time may not be the best option. The stock may be temporarily overpriced, or have recently announced adverse news that could seriously impact on their future outlook.
It is important you realise that when you are re-investing dividends back into your holding you are buying more of that specific stock without re-assessing that purchase decision satisfactorily.
If you were in the early stages of “building” a portfolio and have targeted a certain amount of a specific share then this might be a cost-effective method of acquiring up to the planned allocation of this stock.
Indiscriminate re-investment could also cause an overweight position in your portfolio to certain stocks or sectors and reduce your diversification, thereby increasing your risk.
Increased risk is not always a bad thing, however you need to understand the risk you are taking, be certain you are receiving adequate reward for that increased risk, and understand fully what might happen if it all goes wrong.
Imagine the effect on a portfolio overweight in banking stocks when economic conditions are hard on financials. It becomes more painful to see another sector of the market outperforming when your stocks are languishing.
In spite of generous re-investment discounts I usually advise my clients to accumulate the dividends as cash, and then make an effort to perform adequate research to purchase quality stocks at the best price at that time, giving full consideration to their overall portfolio structure. There are even times when retaining cash can be the best strategy.
Paul Jackson is a Brisbane-based Financial Planner with MacDonnells Financial Services, which is licensed under FYG Planners.
Disclaimer: This article is general in nature and is not intended as investment advice. Readers should always seek further advice before making any financial decisions.