Dividend reinvesting seen as smart in volatile market

To reinvest or not to reinvest — that's a question facing today's nervous investors as they wonder whether it's best to plow back dividend distributions or use the money elsewhere. Most financial advisers and experts said they see opportunity in the beaten-down stock market and recommend dividend reinvestment, provided the client has a diversified portfolio, plans to hold the stock for the long term and isn't a retiree living off the steady cash distributions. "If you plan to hold the asset for quite a long period of time — at least three to five years — then dividend reinvestment makes a lot of sense because you can reinvest and buy more shares per dollar as the unit costs go down for your mutual fund or the stocks that you're purchasing," said Geoffrey VanderPal, a certified financial planner at Elite Financial Planning Group of America Inc. in Las Vegas, which manages more than $100 million in assets. The exception would be retirees relying on dividend payments for daily living expenses, said Stephen Bingham, a certified financial planner at Bingham Financial Advisory LLC in Arlington, Va. While beaten-down share prices offer an opportunity to buy quality stocks cheaply, the recent collapse of high-profile names, such as The Bear Stearns Cos. Inc. of New York, has made many investors wonder if any stock is safe. As a result, advisers are offering different reinvestment strategies, especially for individual stocks, to lower risk. These strategies include hedging investments with stop-loss orders or put options, reinvesting the dividend from an equity fund to a bond fund and, in certain long-term-hold cases, enrolling in dividend reinvestment programs. There's certainly "more volatility and more risk" when reinvesting in individual stocks as opposed to index or mutual funds, Mr. VanderPal said. This is particularly true for stocks that are in volatile, unpredictable sectors, such as the financials, right now. For this reason, Mr. VanderPal recommends to clients that they hedge these investments. "If you're going to buy individual financial service stocks, it may make sense to do collars or purchase put options to help hedge some of the downside risk — or at a minimum, place stop-loss orders on those individual securities to help decrease the loss potential in case things do go south," he said. Diversity is key for Kim Dignum, a Fort Worth, Texas-based certified financial planner with Raymond James Financial Services Inc. of St. Petersburg, Fla. She recommends that investors reinvest equity in-come fund dividend distributions in a bond fund to give them better diversity during this current economic downturn. Ms. Dignum, who manages about $200 million in assets, is cautious on names in the financial services sector and is not recommending that clients jump into it with new investments at this time. Mr. Bingham concurs. "I would be very leery about jumping in at this point, because I think there may still be some more cleaning up to do," he said. In general, most advisers do not recommend that investors plunk cash dividends into a bank account until the market comes back. Advisers noted that dividends are taxed only at a 15% rate, whereas bank account interest is taxed based on taxable-income levels. Some investors are bullish on dividend reinvestment programs, in which investors bypass the broker and reinvest dividends, or even purchase additional shares in a stock, directly from the company. The program appears attractive to penny-pinching investors who want to avoid a broker's fee, and oftentimes, a company will offer the shares at a discount to encourage investors to reinvest. Mr. Bingham, who manages about $20 million in assets, said dividend reinvestment programs work only if they're part of a diversified portfolio and if the investor adds regular payments in addition to the dividend reinvestment into the stock. "I think it can be very effective if the person does the research and diversifies across the industries," he said. Vita Nelson, chairman of Temper of the Times Investor Services Inc., editor of the Moneypaper newsletter and co-portfolio manager of The MP63 Fund Inc., all in Rye, N.Y., believes that dividend reinvestment programs are the best way to build a diversified portfolio of stock holdings over an extended period of time. Aside from her mutual fund, she sets up such programs for clients for a one-time enrollment fee of between $25 and $50 for each account. These accounts allow clients to reinvest dividends or invest new money into the stock directly with the company anytime, although investors can set them up without anyone's help. "If you're trying to build up holdings, then dollar cost averaging is the most efficient and effective way of doing that," Ms. Nelson said. Dividend reinvestment programs are for people who prefer to do their own research on companies, who plan to invest on a regular basis in the companies to build up their holdings and who don't want brokers hounding them all the time with the latest news on another stock, she said. Mr. VanderPal said a dividend reinvestment program is a good strategy if it's a long-term investment, but he cautioned that in-vestors can't hedge risk in such a program. "So if you wanted to put a stop-loss order or a put option, for example, that would not be available in a [dividend reinvestment program]," he said. Ms. Dignum views such programs favorably: "They're forced discipline — if people don't see it, they don't spend it." A dividend reinvestment program will complement, but should never replace, a well-diversified portfolio, she said. E-mail Janet Morrissey at jmorrissey@investmentnews.com.