Pros & Cons of Dividend Reinvestment Plans

by Rose Johnson

Dividend reinvestment plans (DRIPs) allow individual investors to purchase stocks directly from a company. Investors do not need to use a broker to purchase and sell stocks. The dividends paid to investors who own DRIPs are automatically reinvested to purchase additional shares of the company's stock. DRIPs offer investors several advantages and drawbacks. You should understand the features of DRIPs to determine if the investments are worth including in your investment portfolio.

Available to Small Investors

A primary advantage of investing in DRIPs is investors can purchase shares of a company with a small amount of money. Some companies simply require you to own a single share of the stock to enroll in its DRIP program and start making small contributions. Investors buy shares directly from the company, so they avoid paying brokerage fees, which benefits small investors. Some companies require you to sign up for automatic monthly contributions to avoid commission fees.

Own Fractional Shares

DRIPs allow investors to buy fractional shares. For example, if the current share price of a stock is $50 and your monthly contribution is $25, you will own one-half of a share. Buying fractional shares allows investors to keep making contributions regardless of the current price of the stock. This is in contrast to most brokerage firms, which require investors to purchase whole shares. Monthly contributions allow you to take advantage of dollar-cost averaging, which means you buy more shares of a stock when the price is lower and fewer shares when the price increases. Dollar-cost averaging helps you avoid the difficult task of trying to time the market and incorporates a long-term investment strategy.

Loss of Control

Selling DRIPs require contacting the company and going through a specific process, which can take several days. The length of time to sell DRIPs limits the amount of control you have of selling the stock at a particular price. This loss of control can result in you losing profits if the stock declines in value by the time you sell. The same is true when buying DRIPs. You may desire to invest in a DRIP when the stock price is low but the price may increase by the time the transaction is completed. Selling and buying stocks through a broker allows investors to participate in instant transactions.

Tracking Cost

Investors may experience a difficult time tracking the cost of investing in DRIPs. The fact that you make automatic contributions typically means that you purchase shares at difference prices throughout the year. Investors must maintain accurate records of how many shares are purchased for when making monthly contributions. Investors who participate in numerous DRIPs may consider it a burden to track all of the associated costs. Investors must also pay taxes on the dividends that are reinvested, which are taxed as ordinary income. Essentially, investors pay taxes on money that is not physically received.