Reinvestment
Candlefocus EditorOne of the more popular ways to reinvest is through dividend reinvestment plans (DRIPs). In a typical DRIP, any dividend payments received from stocks or mutual funds are automatically deposited into the investor's account and applied toward the purchase of additional shares. This eliminates the need for the investor to manually allocate funds for dividend reinvestment, simplifying the process. Alternately, investors can open separate accounts that only buy stocks with dividend payments, then reinvest these stocks back into the same account.
Reinvestment also offers investors an opportunity to increase the average maturity of their portfolio and reduce reinvestment risk. As the price of an asset declines, the income generated from that asset is reinvested into higher-yielding investments. That increase in yield can be beneficial when market prices are volatile and the income earned on the invested funds can be greater than what would have been earned if the original investment had been held.
Investors should be aware that reinvestment also carries some risk. Reinvestment risk arises when investors believe they are making a safe investment but, due to changes in the market, their original investment becomes less attractive. Instances of this can occur with fixed income and callable securities, as the new investments to be made with distributions are less opportune.
In conclusion, reinvestment can be an effective strategy for investors looking to increase their portfolio’s asset size and gain exposure to different asset classes. When done properly, reinvestment can help investors take advantage of potential market opportunities, just as with any other investing strategy. However, it’s important to consider reinvestment risk when making investment decisions, as changes in the market may reduce the attractiveness of the initial investment and result in less-than-ideal outcomes.