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One of the great things about being the owner of a stock or ETF (exchange-traded fund) is that many of them pay out dividends. While many people choose to take these dividend payments as cash, financial experts often recommend that they be reinvested back into the portfolio to bolster future growth. Investors who use M1 Finance and own dividend-paying stocks and ETFs will have the ability to do this.
However, the method that they use will be slightly different than what they may be used to with other brokerages.
M1 Finance pays investors the dividends they’re owed as the securities within the investor’s portfolio release them. However, instead of using those dividends to buy more of the issuing security, M1 pays them as cash. After reaching $25, the payments are then reinvested across the entire portfolio.
In this post, we’ll explore more thoroughly how dividend payments work and how M1 Finance manages them. We’ll also talk about the importance of these dividend payments and how they can be used to build greater wealth over time.
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How M1 Finance Pays Dividends
To better understand the way that M1 Finance pays investors the dividends they’ve earned, it will be helpful to know where dividends come from and how the process typically works.
Why Do Stocks Pay Dividends?
When a company makes profits, there are many things they can do with it:
- Increase budgets
- Invest in new developments
- Expand business divisions
- Pay off outstanding debt
- Etc.
However, something a lot of businesses will choose to do is give back a portion of the earnings to the shareholders. This is classically a gesture of gratitude by the company thanking the stock owners for their investment and support.
Of course, not all companies choose to pay dividends. For instance, Berkshire Hathaway, the holding company of legendary investor Warren Buffett, has reiterated many times that they prefer not to pay dividends to their shareholders. This is because they believe those funds would be put to much better use under the leadership of Mr. Buffett.
Some investors see dividend-paying stocks as more favorable than those that don’t because, by definition, a company that pays dividends must also be making profits. There is even a well-known group of companies that investors flock to called the Dividend Aristocrats who’ve raised their dividend payments for 25 consecutive years or more.
When Do Stocks Pay Dividends?
Every company decides its own schedule of when it’d like to pay dividends. This is communicated through four important dates:
- Declaration date – The day the upcoming dividend payment is announced by the company’s Board of Directors
- Ex-Dividend date – The day eligibility for dividend payments restarts. If an investor owns the stock before the ex-dividend date, then they will be paid the dividend. If they bought it on the ex-dividend date or after, they will not be eligible for payment.
- Record date – The day after the ex-dividend date. Companies use this day to note their holders of record (i.e., the eligible shareholders).
- Payment date – The day dividends are paid to the shareholders.
In short, you need to own the stock before the ex-dividend date to receive a dividend on the payment date.
For most stocks, this process happens once every quarter. However, some companies choose to use other schedules such as paying once per month.
What is a DRIP and How Does It Work?
Even though shareholders are entitled to receive their dividend payments as income, they can also be offered the ability to buy more shares of stock. This is called a dividend reinvestment plan or DRIP.
Under a DRIP, dividends from the issuing company are used to buy more shares of that company’s stock. The DRIP can be performed by the brokerage or the issuing company itself (if the stock was purchased directly from them).
There are a lot of advantages to investors using a DRIP. Shareholders are given the privilege of buying fractional shares instead of whole shares. Financial experts also claim that using a DRIP can be an easy way to accumulate more shares and compound their wealth faster than normal. More on this below.
Using M1 Finance to Automatically Reinvest Your Dividends
Investors who use M1 Finance will not be able to participate in a traditional DRIP. However, they will be able to use an enhanced version of this service called Auto-Invest.
The way Auto-Invest works is simple. As the investor is paid dividends from their portfolio (or “Pie” as M1 Finance calls it), cash will accumulate in their account. Once that cash reaches a minimum threshold of $25, it will automatically be reinvested across the whole Pie.
Note this is different from a DRIP because the investor is using the dividend payments to buy new shares of all the assets. With a traditional DRIP, dividends are used to only buy assets from the security that paid the dividend.
The benefits of this process are twofold:
- Cash from the dividend payments rarely ever sits idle. With the low $25 threshold, it’s generally reallocated back into the portfolio quickly.
- Because the cash is used to buy shares across the whole Pie instead of just a few select assets, the investor maintains better asset allocation.
Can the Auto-Invest Plan Be Changed?
Yes, M1 Finance users can change their Auto-Invest settings.
By default, the threshold is set up to invest any time the cash balance goes above $25. However, this number could also be set for a higher amount (such as $50 or whatever the user feels comfortable with). Just note that the bigger the number, the longer the delay before the cash gets reinvested.
Another option is to turn off the Auto-Invest feature altogether. This is would be useful to someone who may prefer to wait until the market is in a dip and then wants to manually purchase more assets. Or they might want the dividend payments for other purposes (such as for retirement income).
Where Does M1 Finance Report My Dividends?
Investors who want to see their dividend transactions can look in two places.
The first is on the main dashboard. Under Invest / Portfolio, there will be a value reported that says “earned dividends”.
If they click the link that says “View”, this will take them to a detailed list of all the recent dividend transactions. This same information can also be found under Invest / Activity and then filtering Activity Type for “dividends”.
When You Can Expect Your Dividends from M1 Finance?
Investors who purchase dividend-paying stocks or ETFs may do so because they depend on the income for their living expenses. Understandably then it will be helpful to understand when an investor can expect to receive these dividend payments.
Calendar for M1 Finance Dividends
M1 Finance does not have a pre-determined calendar for paying dividends. Each stock or ETF decides its own unique ex-dividend date and payment date. Because there is an infinite number of combinations that each user could create within their Pie, payment dates will always vary from user to user.
Earned vs Paid Dividends on M1 Finance
Investors using the M1 Finance platform might notice that their earned dividends will appear in their dashboard before they're actually paid them. In other words, they might see a misalignment between their portfolio gains and the transactions listed in their activity feed.
Generally speaking, all dividends are essentially “earned” before they are officially paid. This is again due to the difference between the ex-dividend date and payment date for each stock or ETF. Depending on the company, it can take up to a month for dividends to be paid after the ex-dividend date.
Why Do I Have Negative Dividends?
If an M1 user sees a negative dollar value around the same time as their dividend payment activity, don't misinterpret this as negative dividends or that your assets are somehow taking money away from you. This cannot happen.
Negative transactions are American Depositary Receipt (ADR) fees. ADRs are how US investors can invest in foreign securities. Essentially, it’s a small fee that's paid to a custodian for the service of collecting the foreign dividends, converting them into US dollars, and then adding them to your account.
How Dividend Reinvesting Builds Wealth
The beauty of dividend reinvesting is that it can help to compound wealth-building faster than normal. This is because of the nature of how dividends are being invested:
- The investor uses the dividends to buy additional shares.
- Those additional shares have the potential to increase in value over time.
- Those additional shares also produce more dividends, which then allows the investor to buy even more new shares.
The longer this cycle continues, the greater the potential outcome for the investor.
Example
To illustrate the power of reinvesting dividends, let's create a simple example. Take a generic stock that costs $10 per share and has an annual dividend yield of 5% paid once every quarter.
Now let's assume you bought $1,000 worth of this stock and participate in auto-investing those dividends. What would the activity look like in detail?
- In the first quarter, you'd make a dividend of $12.50 ($10 per share x 100 shares x 0.05 dividend yield x (1/4).)
If this process were to continue (assuming a modest 2% increase per quarter),
- By the end of 1 year, you'd have 104.993 shares valued at $1,136.48.
- By the end of 5 years, you'd have 127.584 shares valued at $1,895.84.
- By the end of 10 years, you'd have 162.778 shares valued at $3,594.20.
By contrast, what if you had chosen not to auto-invest and instead taken the dividend payments as cash? Under that arrangement, no new shares would have ever been purchased and your portfolio would have remained static with the 100 shares you originally purchased.
Under this scenario, the value of your portfolio would not be as much:
- By the end of 1 year, your portfolio would be worth $1,082.43. You would have also received $65.05 in dividends.
- By the end of 5 years, your portfolio would be worth $1,485.95. You would have also received $322.29 in dividends.
- By the end of 10 years, your portfolio would be worth $2,208.04. You would have also received $782.63 in dividends.
As you can see, the more time goes on, the higher your total balance would be as the reinvested dividends are working harder towards your benefit.
In the case of M1 Finance, what's great about their process is that these dividends aren't just being used to buy back more of the original security. They're being spread across the whole portfolio. That means investors are automatically being diversified as well as maintaining better asset allocation than someone else who may be using a DRIP exclusively.
What Will You Do with Your Dividends from M1 Finance?
Receiving dividends from stocks and ETFs can be a great way for investors to earn some positive cash flow from their assets. However, reinvesting these payments back into the portfolio can be an even better strategy for investors who want to increase their earning potential.
Most stocks or brokerages will provide a DRIP to perform this service, M1 Finance follows a modified process called Auto-Invest. With Auto-Invest, account owners will receive their dividends as cash and then reinvest them across the entire portfolio of assets, not just the ones that issued the dividend payment originally. This will make for better diversification and maintain the account owner's asset allocation.
If you're interested in leveraging the power of compound returns to grow your wealth, then you'll want to consider taking advantage of M1 Finance's Auto-Invest feature. As dividends are used to buy more securities, those securities will produce more dividends which can then buy even more securities. It's a cycle that will add to your net worth and bring you even closer to reaching financial freedom.
