Nothing warms our hearts more than a chunky dividend. With distributions heading our way next week, it’s time to think about how to put those bad boys to work.
Cashing out is for the old
Dividends are the reason compounding can apply to investing. Without it, you can only count on share price movements for profit and, as we know, share price movements can be flaky. Once you’re happily retired, you are free to use your dividends for wine. Until then, reinvestment is the way to go.
Dividends are your quarterly investment booster pack. Without investing more of your income, you can get more ETF units or shares. The next time you receive dividends on your new ETF units, you will be receiving dividends on dividends. This sounds a lot like compounding!
How much do I get?
Dividends are paid based on the number of ETF units you hold. It’s usually expressed as cents per unit. If you’re just starting out, the dividend payment is going to be hilariously tiny, because you don’t have many units yet. Once you’ve recovered from the laughter, use your dividend money to buy more units. By the time the next round of dividends come your way, you’ll have another unit earning its keep. Keep at it and over time it’ll be less funny, we promise.
Where should the dividends go?
Dividends come with no expectations or caveats. They get paid out in cold, hard cash. A dividend that comes from one source doesn’t have to go back to that source.
You may have decided to abandon a few of your initial investments in favour of your ETF hero. Those ETFs continue to pay dividends, even if you don’t love them anymore. In the end, you’ll have a pot of money in your share account.
You can put all your dividend income into the ETF you like best, buy more units in the ETF that paid the dividends or split the dividends between ETFs. This is where your ETF investment strategy comes in handy. Take time to remind yourself of your strategy every dividend day.
Why don’t I get dividends?
Some ETFs reinvest dividends on your behalf. They’re called total return ETFs. Instead of buying more ETF units, the ETF issuers increase the value of an ETF unit by the dividend amount. This is great, because you don’t have to pay brokerage to buy more ETF units. However, going this route means you don’t have the option of investing in a different ETF.
If you’re invested in a tax-free savings account, you don’t need to stress the tax on dividends because you’re not paying any*
Outside of your tax-free account, you are liable for two kinds of tax, depending on your investment. In ordinary share investments, you pay a dividend withholding tax of 20%. It’s awful, but that’s not even the worst of it. If your dividends come from property ETFs, they get added to your income on your tax return and are taxed at your income tax rate. If you’re maxing out your 27.5% retirement annuity allowance, your property income will be taxed at a lower rate than if you didn’t contribute to an RA. Depending on your income, this rate could be far higher than even the dividend withholding tax, so try to ensure your property investments are done in a tax-free account.
In a total return ETF, you still pay a dividend withholding tax rate even if you don’t receive any dividends. This gets subtracted from the dividend amount before it’s calculated into the ETF share price. If you hold a total return ETF in a tax-free account, the subtracted tax gets paid into your brokerage account.
*This is mostly true. If you have an offshore ETF, you pay dividends tax where the ETF is domiciled. You are exempt from the 20% dividend withholding tax you would have paid in South Africa. Anything over that still gets paid. This won’t bankrupt you. The big offshore funds are very tax efficient.