Pros and Cons of Dividend Reinvestment Plan Investing

Pros and Cons of Dividend Reinvestment Plan Investing

Many successful income investors use dividend reinvestment plans on at least a few stocks in their portfolio. A DRIP is generally easy to set up, which makes them a popular feature for investors. DRIPs help investors automate their dividend reinvestment’s while lowering the costs of commissions and other fees. There are plenty of advantages to setting up dividend reinvestment plans, but there are also a few disadvantages to consider. This article will focus on some of the pros and cons of a dividend reinvestment plan investing.

Pros

Purchase Fractional Shares

If an investor receives $20 from a dividend payment and the share price of the stock is $40, a DRIP makes it possible to purchase .5 shares. This allows the investor to continue to build their position by reinvesting all of their dividend payments immediately back into the stock without having to wait to buy a full share.

Automated Stock Purchase

These types of plans can be set up to automatically reinvest any dividend payments directly back into the stock. There is no action required by the investor making it a nice option for those of us with hectic lives. It generally takes less than 5 minutes to set up this feature with an online broker.

Commission Free

A great thing about dividend reinvestment plans is that they generally don’t require any commission be paid. Most online brokers don’t charge any commission fees when an investor decides to reinvest their dividends back into shares of the stock.

This is great for the investor as they can lower the overall costs and the broker who gets to hang onto a customer longer by offering this feature.

Pros and Cons of Dividend Reinvestment Plan Investing 2

Cons

Diversification

Setting up a DRIP for the long term can prevent an investor from having a diversified portfolio. It is crucial for the investor to monitor stocks in their portfolio to make sure any dividends should automatically be reinvested.

Initiating New Positions

Many investors use the income they make from dividends to initiate a new position in their portfolio. Using a DRIP prevents this from happening as all the income is reinvested back into the same stocks, leaving no money to open positions in new stocks.

Hassle Tax Tracking

You need to keep excellent records of your transactions if you invest with DRIPs outside of a tax-advantaged retirement account. Making multiple stock purchases each year can give you a very different cost basis for each lot of stocks you own. You can lessen this hassle by investing in an IRA or other tax-advantaged accounts.

See Also: Types of Taxes

Bottom Line

Experienced and successful dividend investors know how to use dividend reinvestment plans to their advantage. In some cases, it makes sense to set up one of these plans to help build a position in a new dividend paying stock.

There are other times when setting up a DRIP just doesn’t make sense. The key is understanding when to use DRIPs and when to leave them alone and manage the dividends yourself.

See Also: Benefits and Downsides of Dividend Stock Investing

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