As great as it sounds to get paid every quarter from your dividend-paying stocks, in the long run, it might be even better if you opt to make a grand total of zero. In fact, it almost certainly will be better for your portfolio's value if you refuse to take a penny in dividends before you start to draw on your portfolio when you retire. And that means if you're spending your dividend income on frivolous things today, you'll be in a much worse spot down the line.
If it sounds confusing how taking less money today could ultimately lead to getting more value, read on, as you're about to learn one of the most important tricks for compounding your wealth.
Dividends are meant for reinvestment
Let's take a look at Omega Healthcare Investors, (OHI -0.26%) a real estate investment trust (REIT) that operates assisted living facilities and skilled nursing properties. At the moment, its forward dividend yield is above 8.8%, and over the last 10 years, its dividend grew by more than 59.5%. This stock is a great example of why you should prefer to make no dividend income most of the time, and this chart explains why.
As you can see, the total return of holding Omega shares is significantly higher than the price returns alone. If you're accepting its dividend payments in cash every quarter and taking the money out of your account, you're only compounding your investment's value via the price returns on its shares. Retaining those dividends and reinvesting them makes the total return over time significantly larger, and that impact only becomes more pronounced the longer you hold your shares and reinvest the dividends.
The fact that the company keeps hiking its payments only enhances the returns for those who opt to not spend their dividends. And declines in the stock price don't change much of anything about the ever-growing gap between reinvestment and withdrawal, as the dividend yield rises when the price dips. Likewise, because of the way that compounding works, the stock itself doesn't need to be growing whatsoever, so long as you keep holding onto your dividends. Your portfolio will still gain in value faster if you are preventing the constant outflow of value from withdrawing your dividends.
Reinvesting consistently is easier when you don't need to think about it
Of course, it's a lot easier to set up the long-term reinvesting of dividends to capture compound growth if you have a dividend reinvestment plan (DRIP) enabled for your shares. With a DRIP, whenever a company pays its shareholders, instead of the cash hitting your account, it is automatically used to purchase as many shares or fractions of shares of that company as possible. That'll prevent you from being tempted to spend the money, and it'll also supercharge the growth of your investment for the years to come.
Most brokerages and retirement accounts provide investors the ability to set up DRIPs for stocks that are eligible, and it's a great idea to enable them for 100% of your holdings, assuming you aren't going to need the cash anytime soon. In some cases, your provider may even automatically enable DRIPs for all of your shares when you first purchase them, which makes the process even easier. But, be aware that your reinvested dividends are still subject to taxes, as you still got an infusion of value into your account from your shares.
When you do eventually want to start realizing a passive income stream from your holdings, you can disable the DRIPs. You'll have significantly more shares accumulated than you might have otherwise due to the years or decades of constant compounding reinvestment, and that means you'll also make a lot more dividend income -- but only if you have the discipline to get paid $0 when you could be getting cash over the years. So don't knock a zero-income strategy for your portfolio until you've tried it, as you might be short-changing yourself by doing otherwise.
