Dividend Investing: Pros and Cons of DRIPS (Dividend Reinvestment Plans)

Dividend Investing: Pros and Cons of DRIPS (Dividend Reinvestment Plans)

People often ask:

- What are the pros and cons of drips?
- Should I invest in a drip?
- How do Drips work?

Dividend Investing: Pros and Cons of Drip Investing:

Drips stands for Dividend Reinvestment plan. Drips are becoming highly popular among investors, and offer many positive benefits, but before you engage in this invest strategy it’s important to know the pros and cons.

If you don’t know how a dividend reinvestment plan works, no worries, because it’s fairly simple to explain. Normally when an investor receives a dividend payment they receive that payment in form of cash.

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In Drip arrangement, instead of receiving cash, the investor receives additional shares of a particular company’s stock.

So instead of receiving $4 in cash from a McDonalds stock, the dividend payment is automatically reinvested to purchase additional shares of McDonalds stock.

In the Drip arrangement it is possible to purchase fractional shares of stock.

Pros

1. (Potential for faster compounding interest) – New cash influxes from dividend payments are being automatically put to work. Your money will not sit idle in the account, because this type of plan generally allows one to purchase partial shares of a company’s stock.

2. Few barriers to entry concerning to the DRIP – Generally Drips’ allow an investor to enroll in the plan even if they only own one share of stock. This allows investors at all levels to participate in the benefit the drip.

3. Generally there are no transaction costs related to DRIPS. Under most circumstances the additional stock reinvestments under the plan are either free or very minimal.

4. The potential to purchase shares at discount. Some companies may allow investors to purchase shares at a small discount if they are enrolled in the Drip. The discount may be as low as 1% and high as 10% depending on the company.

5. Low maintenance investing – You do not to continually think about how to reinvest your dividends. It will all be taken care for you

Cons

1. Loss of flexibility. With the same shares being repurchased over and over again in your portfolio lack of diversification may eventually become an issue in your portfolio. Beyond that, your investment becomes less liquid. To get out of a DRIP arrangement or sale a stock within the drip plan may take additional time and you will not be able to sale your position as easily if you really need to.

2. No physical cash, but taxed on the dividends - In the eyes of the IRS even though you did not receive your dividend payment in the form of cash it is still considered taxable income to you. Reinvested dividends are taxed just like any other dividend. Therefore, if you planning to reinvest all of your dividends through a drip realize that when you go to file your tax return you going to have to pay taxes on the amount of dividends you received for the year.


3. Drip systems can lead to more complicated record keeping for taxes. Brokerage companies often do not keep track of a person’s stock basis once it enters to a drip. As an investor it is very important that you maintain good records of all the dividends reinvestments, because it is going to affect your stocks cost basis for tax purposes.

4. Drips are not suitable for short-term investors. If short-term investing is something you are into then I would not recommend doing a DRIP. Infect you may not be able to.

5. Your dividends may not be receiving highest and best use – Sometimes purchasing additional shares of company stock might not make sense if the company is not doing well. Therefore by investing in the drip you have to consider what other investment choices you are giving.


Summary: In summary drips can be a great investing tool for long-term investors. Drips can minimize transaction costs. It may allow investors to purchase stocks at a discount, and allow even the smallest of investors to participate just by owning one of stock. Having your dividends automatically reinvested will further fuel the compounding interest growth of an investor’s portfolio but remember a drip comes with a price.

The price is the investments become less liquid. Your dividends may not be receiving highest and best use. Tax record keeping becomes more complicated, and an investor will have to pay tax on the reinvested dividends even though they did not receive the money.

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