How Soon Do Stock Profits Have to Be Reinvested?
Stock profits, also known as dividends, are the portion of corporate profits paid out to stockholders of a corporation. Dividend reinvestment plans are often referred to as DRiPs and allow stockholders to purchase additional stock shares in a company. These shares pay a dividend. If you are paid in dividends, you can reinvest them in the company or take them as cash. Reinvesting those dividends at the right time can make a significant impact on your stocks’ performance if you can do without the upfront cash income.
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Dividend Reinvestment Plans
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You have three general ways to go about reinvesting your stock dividends. If you request a reinvestment, most companies will do it for you. Some companies use transfer agents for reinvestment plans, which save the company some time and effort. Transfer agents are normally used if the company doesn’t offer any direct or indirect reinvestment planning strategies. Alternatively, some companies do not offer a cash option at all. Some companies provide stock dividends only, instead of cash. In this case, your stock dividends will be automatically reinvested.
Annual Rate of Return
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The annual rate of return on your investment will impact your reinvestment. During times when you estimate a high rate of return, stock dividends should be reinvested immediately. On the other hand, during times of low annual rates of return, you may consider waiting before reinvesting your stock dividends or you might want to instead cash the dividends. The annual rate of return will depend on a variety of factors including company performance, industry trends and economic circumstances.
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Compounding Returns
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The Standard & Poor’s 500 growth between 2000 and 2010 had reinvested dividends that accounted for 87 percent of total dividends. In the S&P 500, the average dividend paid by stocks was between 3 percent to 4 percent per year, which can most definitely add up over time. For this reason, you should consider reinvesting your stock dividends as soon as possible to reap the full benefits. For example, if you invest $20,000 with a 7 percent annual price gain in your stocks, your account would grown to $299,489 over 40 years. If you took a 3-percent stock dividend and reinvested it over 40 years, that account would grown to $905,185 or more than double its value compared to taking the cash. The sooner the stock dividends are reinvested, the more you can earn.
Taxes
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Reinvesting your stock dividends as soon as possible means that you will also need to pay taxes on them. Dividends are taxed during the year you receive them; however, capital gains on the stocks are taxed only when you decide to sell them. Those capital gains are determined based on what you paid for the stock. Maintain good record-keeping throughout the entire period of your reinvestment plan to ensure proper tax management.
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