Over the many sessions I have taught this course, I have seen many posts from FIN110 students saying that they rather take a cash dividend as opposed to a stock dividend. The rationale, I guess, is that if additional stocks are being given to the shareholder in lieu of cash, the shares may decrease in value in the future.
While this argument may make some sense on the surface, there are two important issues that must also be considered. First of all, where as cash dividends are fully TAXABLE in the year received, additional stocks-in form of stock dividends- are TAX DEFERRED until those shares are sold in the future. Secondly, the “secret” to any type of long term, successful portfolio accumulation program is to increase your NUMBER of stock or mutual funds shares as much as possible over the long run. The more shares you have, the POTENTIAL for all of these share to appreciate over time. So, while stock splits or stock dividends may not do anything drastic for your CURRENT net worth, they are desirable tools for increasing your net worth over the long run. What do you guys think of all of this? Does it make sense to you? Why or why not ?
Also…there are many ways to increase your stock and mutual funds portfolio over time. Reinvesting all dividends and capital gains back into buying more shares in one way. Another way is through a method called DOLLAR COST AVERAGING. Who can tell me HOW dollar cost averaging works and what are some benefits of it? : )
http://en.wikipedia.org/wiki/Dollar-cost_Averaging
I think most economic studies on DCA indicate it is less worthwhile than investing single sums.
The argument presented about taking a cash dividend versus a stock dividend is an interesting one. On the surface, it may seem preferable to receive cash rather than additional stocks, as there is concern that the value of the shares may decrease in the future. However, there are two important factors to consider - tax implications and the long-term potential for increasing your net worth.
Firstly, cash dividends are fully taxable in the year they are received. This means that you will have to pay taxes on the amount of cash dividend you receive, reducing the actual amount you get to keep. On the other hand, stock dividends are tax-deferred until those shares are sold in the future. This can provide a potential tax advantage, as you can delay the tax liability.
Secondly, the key to successful long-term portfolio accumulation is to increase the number of stock or mutual fund shares as much as possible over time. By receiving additional stocks through stock splits or stock dividends, you are effectively increasing your number of shares. The potential for all these shares to appreciate over time can significantly contribute to increasing your net worth. While stock splits or stock dividends may not have an immediate impact on your current net worth, they can be valuable tools for long-term wealth accumulation.
Now, let's discuss dollar-cost averaging (DCA). DCA is a strategy where an investor regularly invests a fixed amount of money into a particular investment, regardless of the investment's price. The idea behind DCA is that by consistently buying at regular intervals, regardless of market conditions, you can reduce the impact of short-term market volatility on your investment.
The way DCA works is that when prices are high, your fixed investment amount will buy fewer shares, and when prices are low, your fixed investment amount will buy more shares. This means that over time, you will end up buying more shares at lower prices, effectively lowering the average purchase price of your investments. This strategy can help mitigate the risk of making large investments at unfavorable times.
There are several benefits associated with dollar-cost averaging. Firstly, it helps remove the need to time the market, as you are consistently investing regardless of market conditions. This reduces the risk of investing a large sum of money at a market high or low. Secondly, it promotes discipline by encouraging regular investment and discouraging emotional decisions based on short-term market fluctuations. Lastly, DCA can help smooth out the overall cost basis of your investments over time.
While it is true that some economic studies suggest that DCA may be less worthwhile than investing a lump sum, it's important to note that these studies are based on historical market data and may not always apply to individual situations. Ultimately, the effectiveness of DCA as an investment strategy depends on various factors, including an individual's risk tolerance, investment goals, and time horizon.
In conclusion, taking cash dividends versus stock dividends involves considering tax implications and the long-term potential for increasing net worth. Dollar-cost averaging is a strategy that can help mitigate short-term market volatility and promote disciplined investing. As with any investment decision, it's essential to evaluate these strategies based on your individual circumstances and consult with a financial advisor if needed.