It's important to reinvest dividends — especially when the stock market is tumbling


Both the S&P 500 and Dow Jones Industrial Average have tumbled into a bear market, and the wild ride in the U.S. stock market isn't over yet. Even as these benchmarks swing higher or lower on a near daily basis, though, dividend payments stay pretty constant.

Many companies and exchange-traded funds (ETFs) offer dividends, or a periodic payout of earnings that they share with investors just for being a shareholder. These payments, typically delivered once a quarter, are a perk that comes with investing, beyond just the appreciation in price of a company's stock.

Whether the market is rising or falling, it's a good idea to reinvest those dividends by buying more shares of the related company or fund, rather than receiving payments as a check. Doing so is a form of compounding: You'll be able to buy more shares over time by reinvesting those dividends.

And when the market's in a slump, reinvesting will help to set you up for an eventual rebound.

What are dividends and why some companies don't offer them

Video by Jason Armesto

"The principle of reinvesting dividends, especially in a market where volatility rules the day, is important because you're accumulating more shares by reinvesting at lower prices," says David McInnis, a certified financial planner and the co-founder of East Paces Group. "The potential for future gain becomes larger by reinvesting dividends."

How dividends help your portfolio

Among the members of the S&P 500, more than 80% currently pay a dividend, according to data from FactSet. So if you're investing in a fund that tracks this index, you'll benefit.

"We find that going back to the mid-1920s, that more than 40% of the S&P 500's total return has come from reinvested dividends," says Sam Stovall, a U.S. equity strategist at CFRA Research and the author of the book "The Seven Rules of Wall Street." "Just knowing that almost half of your return comes from doing nothing and raking in the returns is pretty impressive."

What's more, companies that pay dividends tend to experience less volatile movements in their stock prices compared with those that don't, Stovall says. That stability provides a secondary benefit to investors, in addition to the compounding effect.

The power of compound interest: How it helps an investment strategy

Video by Jason Armesto

While some companies may reduce their dividends during downturns, many continue paying shareholders. General Mills, Procter & Gamble, and Coca-Cola, for example, have paid out dividends every single year for decades. 

That said, there are some companies — Facebook and Amazon are two examples — that don't pay dividends at all. They elect instead to reinvest money back into the business rather than reward shareholders. The trade-off is that many of these companies are considered growth stocks and have performed better than the overall market during various time periods.

The potential for future gain becomes larger by reinvesting dividends.
David McInnis
certified financial planner and co-founder, East Paces Group

Dividends during downturns

While some companies may reduce their dividend payments during slowdowns, most continue to pay out to shareholders, McInnis says. That's why including either individual stocks or funds with a dividend-focused strategy is good for ensuring your portfolio is well-diversified, he adds.

It's important to ask yourself questions before you consider selling an investment at any time but especially so during a market slump. In addition to potential losses and the opportunity cost of eventual gains that you'll forgo by selling in a downturn, if you're not a shareholder you won't be eligible to receive those dividends, Stovall says. 

"You might sell just before a dividend is going to get paid or get back in or after it's been paid," Stovall says. "Why compound a price error with a dividend miss?"

More from Grow: