Dividend investing is becoming more and more popular among investors. The idea behind it is pretty simple and easy to understand. You buy dividend stocks, reinvest your earned dividends and watch your money grow!
Thanks to compound interest, your money grows exponentially.
M1 Finance is one of the most popular choices for a brokerage platform among younger dividend investors. This is because the automation features and dividend reinvestment make it an ideal platform for dividend investors.
Earned dividends can be reinvested automatically, and the dynamic rebalancing keeps your portfolio on track allocation wise.
However, there is more to the story than that.
We will be taking a deep dive into what happens with dividends on the M1 Finance platform.
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To answer the question of what happens with dividends, you have to first consider whether or not you are using auto-invest.
Auto-invest is a feature included with M1 Finance that allows you to automatically invest your cash balance once it hits $25. You are able to turn this on or off as well as set a minimum cash threshold before investing.
If you have auto-invest enabled and your minimum cash balance at $0, your dividends will be reinvested once the cash balance exceeds $25. If the earned dividend does not push your cash balance above $25, it will remain in your cash balance.
However, if you have auto-invest enabled and your minimum cash balance at $500 for example, your dividends would accrue in your cash balance. Once the balance hit $525, the $25 would be automatically invested across your portfolio based on your target allocations set. The $500 would remain in cash.
If you have auto-invest turned off, your dividends will all go to your cash balance and not be invested automatically. You can invest them yourself or withdraw them to your bank account.
When using the M1 Finance app, you may notice that you have both earned dividends and paid dividends. So, what exactly is the difference between these two?
All earned dividends within M1 Finance will show up under market gains in your portfolio. These are the total dividends that you have earned over the life of your portfolio, not necessarily the total you have received yet.
The paid dividends are the amount of dividends you have actually received in cash. Paid dividends show up under each security in your activity feed.
Still a little confused? Don't worry, keep reading.
To understand earned vs paid dividends, we must focus on two important dates; the ex-dividend date and the payable date.
This is the date by which you must own the stock to receive the dividend.
If you buy a stock before the ex-dividend date, you will receive the quarterly dividend. If you buy a stock on or after the ex-dividend date, the seller receives the dividend.
This is the date you actually receive payment of the dividend.
The payable date is typically around one month after the ex-dividend date. If you sell the stock after the date of record, but before the payable date then you are still entitled to a dividend payment.
So, within your M1 Finance portfolio you may see a different number as far as earned versus paid dividends. That is because you may have earned the dividend already, based on the ex-dividend date, but you haven't been paid yet.
Most dividend investors are familiar with a DRIP, or a dividend reinvestment plan.
With a DRIP, the dividends received are used to purchase more shares of the issuing stock.
While M1 Finance does offer reinvestment of dividends, it is a little bit different.
Let's assume you have auto-invest on with a $0 cash minimum.
If a dividend payment pushes your cash balance in your portfolio above $25, the cash is invested across your portfolio. This cash will be used to purchase whatever you are underweight in based on your target allocations.
For example, let's say you built a pie with 50% Boeing stock and 50% General Electric stock.
Fast forward one month and you are now 55% Boeing and 45% General Electric due to the differing performance.
If Boeing pays a dividend and that dividend pushes your account above $25, that money would be allocated into General Electric stock to rebalance your portfolio and return it to a 50/50 split as closely as possible.
We call this a Portfolio Level DRIP as opposed to a Stock Level DRIP.
If you earned a dividend from Boeing or General Electric with a stock level DRIP, the entire dividend would go back into the issuing stock only. With M1 Finance, it is invested across the entire portfolio.
Dividends offer a return of capital to the shareholder without having to sell the stock.
This allows the investor to reinvest dividends and grow their account using compound interest if they wish. Compounding is the ability to reinvest capital (dividends, interest, capital gains) to generate additional earnings over time.
Think about it like this:
If you followed this strategy and reinvested your dividends for 20 years, based on dividends only your $1,000 investment would be worth $2,653.
If you did not reinvest your dividends, your $1,000 investment would be worth $2,000.
($1,000 worth of stock + $50/yr in dividends for 20 years = $2,000)
Obviously in a real world situation, you would have both earned dividends and market gains. The point is, reinvesting dividends can really accelerate returns. This is why compounding is such a powerful tool in the investment world.