The other day on our Discount Brokers discussion board, a new Fool Community member, "buymorestocks," asked an important question: "Can anyone recommend a discount broker that offers dividend reinvestment? I currently use Scottrade and like their service, except for the fact that they do not provide a dividend reinvestment."
You can read the dozen or so responses that he received in the entire thread, but here's my take on the answer.
First off, buymorestocks is on the right track, because reinvesting dividends can be a powerful way to get wealthy. Here are some eye-opening examples from the folks at our Motley Fool Income Investor newsletter service, which tracks and recommends outstanding dividend-paying investments:
(NYSE:PEP): $2,000 invested in Pepsi in 1980 is now worth more than $150,000. You would have started with 80 shares, but by reinvesting dividends, you now would have 2,800 shares.
(NYSE:MO): $2,000 invested in the former Philip Morris in 1980 is worth just less than $300,000 today. Starting with 58 shares, today, thanks to stock splits and reinvesting dividends, you now would have more than 4,300 shares!
Johnson & Johnson
(NYSE:JNJ): $2,000 invested in Johnson & Johnson in 1980 would be worth close to $140,000 today. Though you would have started with only 13 shares of stock, thanks to reinvestment and splits, today you would own more than 2,000 shares.
You'd have a portfolio now worth close to $600,000, starting with a total investment of only $6,000, and without ever needing to add another penny. Today, your little $6,000 investment is generating $17,000 every year in dividends. You're earning almost three times your total original investment every year in dividends alone!
That's why you might want to reinvest dividends. Fortunately, there are a bunch of brokerages offering such a service. According to other Fool Community members who answered his question, for example, their ranks include Fidelity, E*Trade, Muriel Siebert, and Firstrade. (Learn more about some of these and other brokerages in our Broker Center, which offers tips on finding the best brokerage and a handy brokerage comparison table.)
That said ...
Don't rush out and sign up for dividend reinvestment yet, though. This silver lining has a cloud: You end up accumulating lots of little batches of shares and fractions of shares, each with a new cost basis to track. When you sell your shares, you'll have to compute your capital gain (or loss) for each batch for tax purposes. In other words, it can be a record-keeping headache.
If you're keeping those stocks in a tax-advantaged account, such as a Roth IRA, you can neatly sidestep that complication. But if you aren't, there's an alternative that Fools like me like to employ. We simply let our dividend income accumulate in our brokerage account until we have enough cash to deploy into a new investment. This could be a new stock holding for us, or even a new batch of shares in an existing holding. In this situation, you're controlling how many batches of a stock you purchase, and you're more able to invest in other companies. This option will give you much of the benefit of reinvesting dividends, but with fewer tax hassles along the way.