Since I’ve started my journey towards financial freedom dividend ETFs have always played a key role in my portfolio. Not only do they tend to perform well over the long term, but they also pay out a steady stream of income. Today I wanted to take a look at the dividend reinvestment process of the most common ETFs and brokers and ask:
Whether ETF dividends are automatically reinvested depends entirely on your broker. With most brokers – such as Vanguard, TD Ameritrade, and Robinhood – you will be able to enroll your dividend ETF holdings in a Dividend Reinvestment Plan (DRIP). Once enrolled, your ETF dividends will be automatically reinvested.
This of course begs the question: should you automatically reinvest ETF dividends?
In this post, we’ll take a look at some of the most common brokers and see if they offer DRIPs and how you can enroll your funds in them. We’ll also address some tax issues with regards to reinvested dividends and finally discuss if it is better to automatically reinvest your dividends than to have them paid out.
FYI: Another great way to get exposure to the real estate sector is by investing in real estate debt. Groundfloor offers fantastic short-term, high-yield bonds that can add diversification to your portfolio!
Overview of brokers
First, we’ll look at some of the most common brokers and see how they handle ETF dividend reinvestments. The most favorable scenario for you and me as an investor will be to enroll our funds in a DRIP. Additionally, it is beneficial if your broker allows for the buying of fractional shares.
| Broker | Automatic Dividend Reinvestment |
| Vanguard | Yes |
| TD Ameritrade | Yes |
| Robinhood | Yes |
| Schwab | Yes |
| M1 Finance | Yes |
Does Vanguard automatically reinvest dividends?
Vanguard is one of the brokers with the most ETFs available to automatically reinvest dividends. They offer a no-fee no-commissions dividend reinvestment program on all their (Vanguard’s) ETFs, closed-end mutual funds, and Fund Access funds. The only main requirement is that your account is not subject to either backup or nonresident alien income tax withholding.
Besides this, there are some other minor eligibility issues. Vanguard may choose to make foreign equities or ETFs that are highly illiquid ineligible for their DRIP. However, you probably should not be investing in highly illiquid ETFs anyway.
If you stick to their major exchange traded funds such VTI, VIG or VYM you should be fine!
Does TD Ameritrade automatically reinvest dividends?
With TD Ameritrade you basically have all the same option of reinvesting dividends automatically as you have with Vanguard. You can opt into their DRIP by selecting each of your holdings individually or choose to enroll all.
TD Ameritrade offers the same no-fee no-commission dividend reinvestment options as Vanguard does. You will also be able to purchae fractional of almost any funds you choose to invest in.
There is not much information publicly available on any restriction or eligibility requirements TD Ameritrade might have on enrolling funds into their DRIP. Possibly, you will have a hard time with foreign equities and very low-volume ETFs as with Vanguard.
Does Robinhood automatically reinvest dividends?
Robinhood is one of the most popular brokers, especially among Millenials. Their intuitive and user-friendly interface makes investing with little cash and no-commission or fees highly appealing.
One of the downsides of Robinhood is, however, that their platform sometimes is overly simplified. Thorough research or analysis is better done elsewhere. When it comes to DRIPs, Robinhood has recently updated their system to make dividend reinvesting a reality.
With Robinhood’s new DRIP it’s easy to autmatically reinvest your ETF dividends.
As with Vanguard and TD Ameritrade, you can choose which holding to enroll in the DRIP and do so commission-free.
According to Robinhood, your dividends may not be reinvested if “The equity is ineligible for Dividend Reinvestment.” But it remains unclear which exact requirements Robinhood has for enrolling funds in their DRIP.
What happens if you don’t reinvest ETF dividends?
If you choose not to invest your ETF dividends they will generally be paid out in cash and credited to your account. This will occur four times a year usally each quarter.
Vanguard also has the option to have your dividends automatically paid out and transferred to your bank account. This way you can set up a passive income stream from your dividends ETF holdings.
FYI: The best way I've found to invest is through M1 Finance. It's free and you even get an instant line of credit and 100$! Have a look here (link to M1 Finance).
Should ETF dividends be automatically reinvested?
Automatically reinvesting ETF dividends will result in a faster-growing portfolio over time. Not only will your initial capital continue compounding but the dividends received will add to the compounding effect.
Here’s the growth difference of an ETF portfolio with dividends automatically reinvested vs. one without:
| Portfolio | Initial Balance | Final Balance | CAGR |
| Dividends reinvested | $10,000 | $52,498 | 9.08% |
| Dividends not reinvested | $10,000 | $36,814 | 7.07% |
Although the difference may not look like much judging by the graphs the numbers tell a different story. Over 30 years the same $10,000 invested in a total stock market ETF (VTI) would have yielded $52,498 with dividends reinvested but only $36,814 with no dividends reinvested.
This equates to a compound annual growth rate (CAGR) of 9.08% for a portfolio with reinvested dividends and a 7.07% CAGR for a portfolio without dividends reinvested. Thus, from a portfolio growth perspective, it absolutely makes sense to automatically reinvested ETF dividends.
Reinvested Dividends & Taxes
When it comes to ETF dividends, taxes are always a big issue for every investor. While dividends generally are taxed as regular capital gains you can save some money by declaring them as qualified dividends.
In the following section we’ll discuss some common tax questions related to DRIPs and dividend reinvestment in general.
Are reinvested ETF dividends taxable?
If you reinvest your ETF dividends automatically you don’t even see the money so there’s no tax right?
Wrong.
Even though DRIPs make it so that you never see the cash in your account from a tax perspective you receive capital gains. This means that even ETF dividends that are reinvested through DRIPs are taxable. Holding ETFs for a longer period of time will allow you to declare those reinvested dividends as qualified which can significantly reduce your tax burden.
How can I avoid paying tax on dividends?
If you are looking to avoid paying tax on dividends at all (for now). You may consider opening a tax-shielded account such as a Roth IRA. However, once you withdraw money from these type of accounts you will have to pay ordinary income tax which may end up being for then the long-term capital gains tax rate for qualified dividends.
Besides putting your money away for the long-term and late retirement, the only option is to make sure to hold your funds for longer than 60 days and pay the lower capital gains rate on your reinvested dividends.
How do ETFs avoid capital gains?
Compared to mutual funds ETFs offer other tax benefits. Although ETFs cannot avoid capital gains completely they can lower the tax burden that is passed on to investors.
This is because ETFs follow and index while in a mutual fund the fund manager picks the stocks. Thus, they tend to have a higher fluctuation of companies held in the fund. Each time a stock is sold investors are exposed to possibly paying (be it indirectly) capital gains.
NOTE: The easiest way to add diversification to your portfolio is to invest in real estate through Fundrise. You can become private real estate investor without the burden of property management! Check it out here (link to Fundrise).
Conclusion
We’ve looked at how ETF dividends can be automatically reinvested through dividend reinvestment programs (DRIPs). We’ve also compared options for automatically having your ETF dividends reinvested with Vanguard, TD Ameritrade and Robinhood.
However, there is one questions I have not addressed yet: should I reinvest ETF dividends?
For me, this comes down to personal preference. If you prefer setting your investments on auto-pilot having your dividends reinvested automatically once they are paid out may be the right option for you. This will also allow you to make the most of compound interest.
I prefer having dividends paid out on a regular basis and use them as part of my cash flow stream. This combined with cash flow from real estate and other sources can create an attractive passive income stream on the side. It all depends on your own personal investment goals.
Current recommendations:
Over the past years, I have discovered several tools and products that have helped me tremendously on my path to financial freedom:
P.S.: The links below are affiliate links, which means I receive a small commission at no extra cost to you when you sign up for one of the services. Thank you for your support!
1)Personal Capital is simply the best tool out there to track your net worth and plan for financial freedom. Just their retirement planner alone has become an invaluable tool to keep myself on track financially. Try it out, it's free!
2) Take a look at M1 Finance, my favorite broker. I love how easy it is to invest and maintain my portfolio with them. I can set up automatic transfers, rebalance my portfolio with one click and even borrow up to 35% of my assets at super low interest rates!
3) Fundrise is by far the best way I've found to invest in Real Estate. You can diversify your portfolio by investing in their eREITs or even allocate capital to individual properties (without the hassle of managing tenants!).
4) Groundfloor is another great way to get exposure to the real estate sector by investing in short-term, high-yield real estate debt. Current returns are >10% and you can get started with just $10.
5) If you are interested in startup investing, check out Mainvest. I've started allocating a small amount of assets to invest in and support small businesses. Return targets are between 10-25% and you can start with just $100!
To see all of my most up-to-date recommendations, check out the Recommended Tools section.
I believe that money is just a means to an end: to be free to spend your time as you wish, to maximize your positive impact on the world.
