Here's what happens when you cash out your ASX dividends

Should you use a dividend reinvestment plan for your share payouts?

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One of the things that ASX investors love the most would have to be dividends. Most ASX shares on the Australian stock market pay out some form of dividend to their investors.

This passive income from your shares forms a major component of the overall returns you can expect from your investing portfolio.

How dividends work

Dividends are cash payments made to the owners (shareholders) of a company out of its profits. Most ASX shares pay a dividend every six months. However, some investments offer quarterly or even monthly payments.

In Australia, a dividend might also come with franking credits too if the company has paid Australian tax on its profits. These franking credits can boost your investing returns even further. That's either by giving you a tax deduction or else by allowing a cash refund for certain investors.

How can you receive ASX dividends?

Every company that pays out a dividend will give you the option to receive the payment in cash. This typically comes via an electronic funds transfer these days.

But some companies also give investors the option to opt for a dividend reinvestment plan (DRP) instead. If you go with a DRP, instead of receiving a cash payment, your dividend will be used to purchase additional shares in the company. This can help to boost the compounding process. That's thanks to your new shares paying you out the next time it's dividend payday.

Keep in mind that you still have to declare your dividends as income for tax purposes, even if you opt for the DRP. Sorry, there's no free lunch there.

Using a DRP

Some investors love the simplicity of a DRP and its 'hands-off' nature. However, there can be a strong case made for either employing a DRP or cashing out your dividends.

On one hand, using a DRP does streamline the investing process. You are never tempted to pull your dividend cash out of your brokerage account on a big night out. Or else use the money for any other purpose that you might regret later. And DRPs do help to harness the power of compound interest very effectively, as you don't usually have to pay brokerage charges on your new shares.

Additionally, there is an opportunity cost to investing. Every dollar you don't reinvest is another dollar that isn't working in the markets for you. The stock market tends to go up far more often than it goes down and has never failed to exceed a previous all-time high.

By that logic, it doesn't make much sense to hoard money in your brokerage account and not put it to work. That's the cost of cashing out your ASX dividends.

Should you cash out your ASX dividends?

But on the other hand, many investors like to exercise full control over their own buying and selling actions. You might be waiting for an opportunity to buy a company for a bargain share price. As such, it might be useful having that dividend cash lying around in case there is a big share market sale.

And you are still buying shares for all intents and purposes when you use a DRP. What are the chances that on the day your dividends reinvest into a company, it would be the single best investment idea that you could think of at that moment for your money? Chances are the stars won't always be perfectly aligned.

So at the end of the day, using a DRP for your ASX dividends has both benefits and drawbacks. It will probably have to come down to your own personal investing style when deciding whether to cash out your dividends or not.

Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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