# Reinvestment: Definition, Examples, and Risks

> **Definition**
>
> Reinvestment is using income distribution from an investment, such as dividends or interest, to buy additional shares or units of that investment instead of taking the cash.

## What Is Reinvestment?

Reinvestment is the practice of using dividends, interest, or other forms of [income](https://www.investopedia.com/terms/i/income.asp) distribution earned from an investment to purchase additional shares or units of that investment, rather than receiving the [distributions](https://www.investopedia.com/terms/d/distribution.asp) in cash. This strategy can help investors grow their holdings over time, potentially leading to significant wealth accumulation.

### Key Takeaways

*   Reinvestment is when income distributions received from an investment are plowed back into that investment instead of receiving cash.
*   Reinvestment works by using dividends received to purchase more of that stock, or interest payments received to buy more of that bond.
*   Dividend reinvestment plans (DRIPs) automate the reinvestment of dividends into more shares of a stock or other investment.
*   Reinvestment risk occurs when reinvesting proceeds results in a less favorable return compared to the original investment, especially in fixed-income securities.  
    

## Understanding Reinvestments

Reinvestment is an effective strategy to increase the value of a [stock](https://www.investopedia.com/terms/s/stock.asp), mutual fund, or [exchange-traded fund (ETF)](https://www.investopedia.com/terms/e/etf.asp) investment over time. It is facilitated when an investor uses proceeds distributed from the ownership of an investment to buy more shares or units of the same investment.

Proceeds can include any distribution paid out from the investment including dividends, interest, or any other form of distribution associated with the investment’s ownership. If not reinvested these funds would be paid to the investor as cash. [Social enterprises](https://www.investopedia.com/terms/s/social-enterprise.asp) mainly reinvest back into their own operations.

### Dividend Reinvestment

Dividend reinvestment plans, also known as [DRIPs](https://www.investopedia.com/terms/d/dividendreinvestmentplan.asp), allow investors the opportunity to efficiently reinvest proceeds in additional shares of the investment. Issuers of an investment can structure their investment offerings to include [dividend](https://www.investopedia.com/terms/d/dividend.asp) reinvestment programs.

Corporations commonly offer dividend reinvestment plans. Other types of companies with public offerings such as master limited partnerships and [real estate investment trusts](https://www.investopedia.com/terms/r/reit.asp) can also institute dividend reinvestment plans. Fund companies paying distributions also decide whether or not they will allow dividend reinvestment.

Investors investing in a stock that is traded on a public exchange will typically enter into a dividend reinvestment plan through their [brokerage](https://www.investopedia.com/best-online-brokers-4587872) platform elections. When buying an investment through a brokerage platform, an investor has the option to reinvest dividends if dividend reinvestment is enabled for the investment.

Investors who choose to participate in DRIPs usually have the option to change their reinvestment preferences anytime via their brokerage platform. If dividend reinvestment is enabled, it typically occurs without commission fees, making it a cost-effective way to increase one's holdings in the investment.

### Income Investments

Reinvestment is an important consideration for all types of investments and can specifically add to investment gains for income investors. Numerous income-focused investments are offered for both [debt](https://www.investopedia.com/terms/d/debt.asp) and equity investments. The Vanguard High Dividend Yield Fund (VHDYX) is one of the broad market’s top dividend [mutual funds](https://www.investopedia.com/terms/m/mutualfund.asp). It is an index fund that seeks to track the FTSE High Dividend Yield Index. It offers investors the opportunity to reinvest all dividends in fractional shares of the fund.

Income investors choosing reinvestment should be sure to consider taxes when reinvesting paid distributions. Investors are still required to pay [taxes](https://www.investopedia.com/terms/t/taxes.asp) on distributions regardless of whether or not they are reinvested.

> **Important**
>
> Zero-coupon bonds are the only fixed-income instrument to have no investment risk since they issue no coupon payments.

## Special Considerations: Reinvestment Risk

Although there are [several advantages to reinvesting dividends](https://www.investopedia.com/articles/investing/090915/reinvesting-dividends-pays-long-run.asp), there are times when the risks outweigh the rewards. For example, consider the reinvestment rate, or the amount of interest that can be earned when money is taken out of one [fixed-income investment](https://www.investopedia.com/terms/f/fixedincome.asp) and put into another. Essentially, the reinvestment rate is the amount of interest the investor could earn if they purchased a new bond while holding a [callable bond](https://www.investopedia.com/terms/c/callablebond.asp) called due because of an interest rate decline.

If an investor is reinvesting proceeds, they may need to consider reinvestment risk. [Reinvestment risk](https://www.investopedia.com/terms/r/reinvestmentrisk.asp) is the chance that an investor will be unable to reinvest cash flows (e.g., coupon payments) at a rate comparable to the current investment's rate of return. Reinvestment risk can arise across all types of investments.

Generally, reinvestment risk is the risk that an investor could be earning a greater return by investing proceeds in a higher returning investment. This is commonly considered with fixed income security reinvestment since these investments have consistently stated rates of return that vary with new issuances and market rate changes. Prior to a significant investment distribution, investors should consider their current allocations and broad market [investment options](https://www.investopedia.com/terms/i/investment.asp).

For example, an investor buys a 10-year $100,000 [Treasury note](https://www.investopedia.com/terms/t/treasurynote.asp) with an interest rate of 6%. The investor expects to earn $6,000 per year from the security. However, at the end of the term, interest rates are 4%. If the investor buys another 10-year $100,000 Treasury note, they will earn $4,000 annually rather than $6,000. Also, if interest rates subsequently increase and they sell the note before its maturity date, they lose part of the principal.

## Do Investors Pay Taxes on Reinvested Dividends?

Yes, investors must pay taxes on any dividends they receive, whether or not they are reinvested. Reinvestment doesn’t exempt you from tax liabilities.  

## Can I Reinvest in Any Investment?

Not all investments offer the option for reinvestment. Stocks, mutual funds, ETFs, and some types of bonds typically allow reinvestment, especially through dividend reinvestment plans (DRIPs). However, certain assets, like [real estate](https://www.investopedia.com/terms/r/realestate.asp) or non-dividend-paying stocks, may not offer an automatic reinvestment option.  

## Is Reinvestment Always a Good Strategy?

Reinvestment can be a good strategy for long-term growth, but it may not always be ideal. For example, if the investment’s performance declines or if you require cash flow for other purposes, reinvesting might not be the best option. Always consider your [investment goals](https://www.investopedia.com/investing/figure-out-your-investment-goals/) and current market conditions before reinvesting.  

## The Bottom Line

Reinvestment is a valuable strategy for growing your investment portfolio, especially through dividend reinvestment plans (DRIPs) and for income investors who focus on debt and equity investments. However, it is essential to be aware of reinvestment risks, particularly in fixed-income securities, where lower interest rates or other market changes could lead to less favorable returns.  

Before committing to reinvestment, investors should carefully assess their investment strategy and consider their tax situation, as well as [market conditions](https://www.investopedia.com/articles/technical/03/060303.asp), to make informed decisions.

> **Article Sources**
>
> 1.  European Commission. "[Creating a Favorable Climate for Social Enterprises: Key Stakeholders in the Social Economy and Innovation](https://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2011:0682:FIN:EN:PDF)," Pages 2 and 3.
>     
> 2.  Vanguard. "[Vanguard High Dividend Yield Index Fund Investor Shares (VHDYX)](https://investor.vanguard.com/mutual-funds/profile/VHDYX)."
>     
> 3.  Internal Revenue Service. "[Publication 550: Investment Income and Expenses](https://www.irs.gov/pub/irs-pdf/p550.pdf)," Page 20.