Reinvesting dividends is often considered a simple strategy to build long-term wealth. Instead of taking dividend payouts as cash, when you use the extra income to buy more units of a mutual fund or shares of a company, you let your investments grow through compounding.
That said, it is also worth noting that this strategy does not work for everyone. For some, it may make more sense to take the cash, especially if an investor is nearing retirement, needs the money, or is trying to avoid unnecessary taxes.
Knowing when to reinvest and when to hold on to the money can help you make better financial decisions based on your needs.
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When It Makes Sense To Reinvest Dividends
Here are a few instances when it might be beneficial for you to reinvest your dividends.
1] You Are Investing For The Long Term: If you are investing with a long-term view, such as for retirement or wealth accumulation over decades, reinvesting your dividends can be a powerful strategy.
“By reinvesting, you buy more units every time a dividend is paid out, which can grow over time thanks to compounding. This works best when the market is rising or recovering,” says Soumya Sarkar, co-founder, Wealth Redefine, an Association of Mutual Funds in India (Amfi) registered mutual fund distributor and financial planning firm.
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2] You Are Young: If you are young, chances are you do not need dividend payouts to cover your expenses, so letting that money stay invested can quietly work in your favour and build wealth over time.
Cheenu Gupta, senior vice president – fund management, equities, HSBC Mutual Fund, says, “Individuals in their 30s, who are typically in the wealth accumulation phase, are better positioned to reinvest dividends to take full advantage of long-term compounding. Since their income needs are usually met through employment or business, allowing dividends to stay invested can significantly boost long-term portfolio growth.”
3] You Are Investing In Tax-Saving Instruments: Reinvesting dividends also makes sense when investing in tax-advantaged products, such as equity-linked savings schemes (ELSS), Unit-linked insurance plans (Ulips), or the National Pension System (NPS). Gupta says, in such cases, reinvesting dividends can further enhance returns by deferring tax on gains or enjoying tax-free compounding, depending on the product structure.
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“This makes dividend reinvestment not only financially prudent, but also tax-efficient in the long run,” she adds.
When It Makes More Sense To Take The Cash
Here are the instances when it makes sense to take the cash.
1] You Need Regular Income: For retirees, or anyone using their investments to manage daily expenses, taking dividends as cash can offer a steady, reliable source of income when it is needed most.
“If you need regular income, such as retirees who rely on cash payouts, taking dividends as cash makes more sense. Also, if the fund is not performing well, getting cash may be better than reinvesting in a struggling investment,” says Sarkar.
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Gupta adds that dividends can also serve as a supplementary income stream for individuals with irregular income or spending needs. “In such cases, taking dividends as cash offers flexibility during periods of financial uncertainty,” she adds.
2] When Market Is Overvalued: When markets look overpriced, it can be wise to hold on to your dividends in cash rather than reinvesting at higher valuations.
Says Gupta, “During periods of market overvaluation, investors may choose to hold dividends in cash and wait for a better entry point.” However, she cautions that this approach involves market timing, which can be difficult to execute consistently.
Sarkar adds, “If you need money for emergencies or big expenses, cash payouts help without selling your investments.”
3] Tax Efficiency: Dividends are taxed as income in India. So, if you are in the higher income tax bracket, reinvesting your dividend income may lead to a higher tax burden. In such cases, Sarkar says, taking cash and investing elsewhere, such as in tax-efficient options, could save money.
Gupta adds that opting for growth mutual fund options can sometimes help reduce tax liabilities by deferring tax until redemption.
“Growth mutual fund options defer taxes until redemption and are taxed at more favorable long-term capital gains (LTCG) rates. Investors seeking to optimise their LTCG exemption or offset capital gains with losses may also benefit from not reinvesting dividends automatically.”
Gupta suggests seeking guidance from a financial advisor or a chartered accountant to figure out what works best for one’s specific tax situation and cash flow needs.
4] You Are A Retiree: For retirees who no longer earn a regular income, dividends can act as a reliable source of cash flow to cover day-to-day expenses, says Gupta. However, she adds that any surplus dividend income, beyond what is needed for monthly expenses, can still be reinvested to support long-term portfolio stability and growth.
Sarkar adds that older investors often prioritise stability over aggressive growth. In such cases, he suggests that taking dividends as cash and locking in the returns, rather than reinvesting in a potentially volatile market, may be a wiser choice.
