“Christine, what can I do with the income from my investment?” This is a question I’m often asked by prospective and current clients. My response is generally the same: “It depends on your goals and financial needs”. Truly there is no right or wrong answer as it depends on the individual and what ultimately works for them.
Investment income is the profit you earn from your portfolio. The income you receive may be dividends from stocks, funds (for example mutual, ETFs, REITS) or coupon payments from bonds. Many older clients' investment strategy is to create a passive income stream to supplement (or replace) their traditional income. In these instances, interest payments will provide some or all the income necessary to cover the expenses of day-to-day life. Many of these clients will use the income and not reinvest it.
On the other hand, there are investors who are still actively working or have alternate income streams so their focus is building their portfolio. These investors are growth focused so generally they will reinvest their income. Reinvesting your income is not without risk but there are great benefits to choosing this strategy and today I’ll highlight a few.
For clients who hold stocks or traded managed funds, many companies have dividend reinvestment programmes commonly known as DRIP. These programmes allow investors to automatically use their dividends to purchase additional shares/units in the respective security. This is a balanced and easy way to increase your holdings over time. The additional investment can potentially grow in value and boost your overall returns in the future. This will also help achieve dollar cost averaging, however there are cons to a DRIP programme. When you subscribe to reinvestment programmes you cannot predict the future and have no control over the price at which you will be buying additional shares, so this could happen when the price is high or low. Investors should also consider if they are willing to increase their exposure to that particular security.
Reinvesting interest income also has the benefit of compounding interest. Simply put, by reinvesting your interest will result in your interest earning interest. Investors should never overlook the power of compound interest over time.
For bond holders a common dilemma is what to do if the income is not enough to purchase additional face value of a bond they hold. For these investors you may consider placing the funds in a savings account or on a short term investment product with lower minimums. In this case your interest will still benefit from compounding, and you may then use the accumulated income to pivot into another investment opportunity.
Reinvesting income is a convenient way to ensure you are making additional investments to facilitate growth of your portfolio. When deciding if reinvesting is right for you, ensure you monitor the security, and analyze whether your portfolio is aligned with your financial goals and time horizon. If the security is not performing well, you need cash for a short term goal, or are becoming overweight in that particular security you should consider alternatives for your income. A well- balanced portfolio is key to your financial success and with any investment decision it’s always a good idea to speak with a licensed financial advisor.
Christine Rankine is the Manager -Personal Financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm
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