Although we’ve written about whether you should reinvest dividends before (and we’ve spilled plenty of ink on how reinvesting dividends can lead to powerful compounding growth), one question we’ve never addressed before is this: When should you stop reinvesting dividends?
In other words, assuming you’ve been reinvesting for years, when is the right time to unclick that box (or call your broker) and start letting your dividends build up cash in your account?
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For the most part, especially if you’re a young investor, reinvesting dividends is the right habit to have. But there are times when your financial situation changes that should prompt you to reconsider.
When to Stop Reinvesting Dividends
So, when is the right time to stop? There’s no one-size-fits-all answer, but here are the most common scenarios where cash payouts may be better than reinvestment:
When You Need Income in Retirement
The most obvious point to stop reinvesting dividends is when you need cash flow to fund your lifestyle. If you find yourself reinvesting dividends but being forced to sell shares of stock to cover living expenses, you may want to stop reinvesting the dividends.
You can do this on a stock-by-stock basis or make the change wholesale. Either way, if you’re using dividends to cover living expenses or supplement Social Security or pension income, and you find yourself selling shares, turning off automatic reinvestment can simplify your investing.
When You Want to Reduce Risk
Over time, dividend reinvestment can concentrate your portfolio in a handful of stocks or funds that keep paying out. This can expose you to sector or company-specific risks. And, given the high allocation to high-flying tech stocks in even basic index funds, this has never been more of a risk than it is now.
By stopping reinvestment, you can collect cash dividends, reallocate into other investments and maintain better control over your portfolio.
For example, if one stock has grown to 20% of your portfolio due to reinvestment, taking dividends in cash allows you to trim exposure without selling shares outright.
When Valuations Look High
If the market—or the specific stock or fund you hold—is trading at stretched valuations, it might not make sense to keep reinvesting dividends. If you periodically rebalance your portfolio, you’re automatically doing this by selling the outperformers to buy underperformers.
But if you find that you are either a) rebalancing more frequently than you expected, or b) persistently selling just one fund or stock, you might want to stop reinvesting dividends in that investment.
You can also consider taking dividends in cash to build up some “dry powder” for more promising opportunities down the road.
When You’re Building an Emergency Fund
If your finances are generally in solid shape but you’ve depleted (or never built up) your emergency fund, you may want to stop reinvesting dividends and set some of that cash aside.
After all, selling invested assets to cover emergency expenses can trigger a capital gains liability, which means that not only will you have to sell stock to pay for your emergency, but you’ll also have to either sell additional shares to give Uncle Sam his cut or face a tax bill when you next file.
Once your emergency fund is established (generally three to six months’ worth of expenses), you can choose to resume reinvesting.
As a rule of thumb, you want to reinvest dividends. Anything you can do to make investing more automatic will contribute to your long-term success. But every once in a while, it does make sense to stop reinvesting in dividends.
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*This post has been updated from a previously published version.