For Anyone Asking: Is Dividend Reinvestment Good Or Bad?
Today, I would like to review the pros and cons of reinvesting dividends. To help you decide if dividend reinvestment is right for you.
No matter if you want to participate in company-sponsored dividend reinvestment plans (DRIPs). Or, are considering asking your stock broker to reinvest dividends on your behalf.
Either way, the advantages and disadvantages of dividend reinvestment are similar using either method.
Let’s get started…
Pros And Cons Of Reinvesting Dividends
For your consideration, here are our top pros and cons of DRIP investing:
- An excellent way to compound wealth
- Passive savings reduces the risk of spending dividends
- Benefit from dollar cost averaging
- Set it and forget it investment approach
- Some company-sponsored plans offer discounts
- Commission-free share accumulation
- New funds are put to work immediately
- No issues with buying and holding fractional shares
- Loss of control over investment decisions
- May create portfolio imbalances
- Bad technique for short-term investors
- Lost access to your dividends
- Income taxes must still be paid
- More investment administration is required
- Some company-sponsored plans charge fees
Next, let’s go through each of these points in greater detail…
Disclosure: At no cost to you, I may get commissions for purchases made through links in this post.
An Excellent Way To Compound Wealth
By reinvesting dividends, you start to build a dividend income snowball.
Because you create a wealth-compounding effect. By earning more dividends in the future. On the dividends you receive today.
Thus, accelerating your path to financial independence. The point in time when your dividend income exceeds your expenses.
Passive Savings Reduces The Risk Of Spending Dividends
By putting your dividends to work in additional shares immediately upon their receipt. Cash never enters the picture.
So, by not seeing cash sitting in your account. You won’t be tempted to pull it out and spend it.
It is similar to when your employer deducts your 401(k) contribution directly from your paycheck. Another form of forced savings.
Benefit From Dollar Cost Averaging
Dollar-cost averaging (DCA)is an investment technique. Where equal sums of money are invested consistently over time.
Thus, more new shares are purchased when stock prices are lower. And fewer additional shares are bought when prices are higher.
As a result, DCA usually results in an overall lower per share cost basis.
And opting to reinvest dividends. Is a good way to benefit from dollar cost averaging.
Set It And Forget It Investment Approach
Once you set up your dividend reinvestment program. No matter if you do it through your stock broker. Or, one or more company DRIP plans.
You won’t have to worry about investing the cash received from your dividend payments. Because it’s done for you automatically.
This is perfect for those of us who procrastinate. Or suffer from indecision. Specifically, about what investments to make and when to make them.
Next, I have another one of the best benefits of dividend reinvestment plans…
Some Company-Sponsored Plans Offer Discounts
In some cases, company-sponsored DRIPs reinvest your cash dividends at discounted prices. Versus the market value of the stock at the time of reinvestment.
It may only be a couple of percentage points. But hey, every little bit helps.
And on the day of reinvestment. You get an immediate and positive return!
Because you bought the stock for less. Versus what it’s trading at in the stock market.
But beware, and be sure to read the fine print. Because not all plans offer discount purchases.
Commission-Free Share Accumulation
Reinvestment transactions are done at no cost to the dividend investor. And keeping investment costs low is critical for maximizing investment returns.
However, with so many brokers offering commission-free trading. This isn’t as big of a deal as it used to be.
Because years back, many brokers especially full-service ones. Sometimes charged hundreds of dollars to execute a trade. Fortunately, for us DIY dividend investors, those days are behind us.
More recently, brokers offering commission-free trades are part of the “new normal”. So, this specific benefit of dividend reinvestment plans is not as critical as it was in the past.
New Funds Are Put To Work Immediately
Research has shown that the best time to invest in stocks is now. Because over the long-term high-quality stocks always go up in price.
As a result, the sooner you get your money invested. The better.
And by automatically reinvesting dividends. Your money is put to work right away.
This has 2 benefits. First, by increasing your dividends over time. Second, immediately creating the opportunity for capital gains.
Making this is one of the very good benefits of dividend reinvestment plans.
No Issues With Buying And Holding Fractional Shares
By reinvesting dividends, every last one of your dividend dollars gets invested. And this almost always results in the purchase of fractional shares.
Once again, this is not as huge of an advantage of dividend reinvestment as it used to be. Because more stock brokers are offering options to purchase fractional shares. Whether you reinvest dividends, or not.
Okay. That concludes my discussion about the benefits of dividend reinvestment plans.
But an article about the pros and cons of reinvesting dividends would not be complete. With addressing dividend reinvestment plan disadvantages.
So, let’s do that next…
Loss Of Control Over Investment Decisions
If you are the type of person that likes to have total control. Then dividend reinvestment plans may be a bad choice.
Because you lose some influence over your investment decisions. Specifically, timing, price, and quality.
First of all, the timing of your investment and the purchase price is dictated by when your dividends are paid. Furthermore, reinvestment will be made even if the stock has declined in quality and safety.
Essentially, you get what you get when you get it!
And when there are top-notch investment tools to take advantage of. Such as the Simply Investing Report and Analysis Platform.
You can have so much more control over your investments. By investing in the best dividend stocks. And buying them at the right time to maximize your returns.
May Create Portfolio Imbalances
By passively allowing dividends to accumulate in the stocks that paid them. Even the best dividend portfolio can get out of whack.
First of all, dividend stocks as a whole may become too large a part of your asset allocation.
Furthermore, one or more individual stocks can become too large. Compromising your diversification and allocation to dividend stocks in this way.
Bad Technique For Short-Term Investors
Dividend reinvestment is a poor technique for a high-volume stock trader. Or, investors with short-term time horizons.
Because reinvesting dividends is a long-term investment technique suitable for achieving long-term success with your investments.
So, if you need the money for an important purchase in the near term. Or, you will get nervous and bail out of your stocks at the first sign of trouble.
Then, are dividend reinvestment plans a good idea? The answer is no!
Lost Access To Your Dividends
Dividends are paid in cash. And cash has value.
If you need your dividends in retirement to pay for living expenses. Or, you have better investment opportunities at any time in life.
By reinvesting dividends, immediate access to the cash is lost. Without selling shares.
For example, you may want to let your dividends accumulate. Then take advantage of the dividend stock recommendations from the Motley Fool Stock Advisor.
To put your money to work. In new and different ways.
Income Taxes Must Still Be Paid
One of the biggest misconceptions about reinvesting dividends is related to income taxes.
Because it doesn’t matter whether you take your dividends in cash. Or, reinvest them.
Taxes are usually still due. Of course, it depends on your specific tax situation. So, I suggest you consult with your tax accountant.
One notable exception is if you buy and hold your dividend stocks in a Roth IRA or traditional IRA (individual retirement account).
Then you can either defer or eliminate income taxes due. On both ordinary and qualified dividends.
More Investment Administration Is Required
Dividend reinvestment increases the amount of administration and record keeping.
First of all, it’s difficult to calculate return on investment. Because of the multiple small purchases continually made over the long-term.
Furthermore, those multiple small purchases. They also make it more complex to calculate your tax cost-basis in the shares.
Because each reinvestment adds to the cost basis. Lowering your taxable long-term capital gains versus the dividends reinvested.
Finally, when you participate in more than one company-sponsored DRIP. Chances are at tax time you will have to deal with multiple tax forms.
Pro tip: Reinvesting dividends through a stock broker minimizes some of these company-sponsored dividend reinvestment plan disadvantages.
Because your stock broker is required to track and report your tax cost basis. And they also provide consolidated reporting at tax time. For all of your holdings.
Finally, some sophisticated investment apps can even calculate your return on investment. Even taking into account numerous small purchases over long periods.
Some Company-Sponsored Plans Charge Fees
Finally, it’s important to do your research and read the fine print. When you get involved with company-sponsored DRIPs.
Some may charge fees for selling shares. Or, terminating your account altogether. Making it more challenging, each different plan will have its own set of rules.
Okay. That completes my review of dividend reinvestment plans pros and cons. So, allow me to close with a few parting thoughts…
Pros And Cons Of Reinvesting Dividends
There are many benefits of DRIP investing. And in certain circumstances, reinvesting dividends is an excellent choice.
Specifically, this technique is one of the best ways to compound your wealth. Using a long-term dividend investment strategy.
However, there are also multiple disadvantages to dividend reinvestment plans.
Most noteworthy is the loss of control over your investment decisions. As well as the additional administration that comes with these programs.
So carefully consider all of the pros and cons before getting involved with DRIPs and broker-managed dividend reinvesting.
Here is a summary of the points you need to consider when deciding for yourself: is dividend reinvestment good or bad?
15 Reinvesting Dividends Pros And Cons
- An excellent way to compound wealth
- Passive savings reduces the risk of spending dividends
- Benefit from dollar cost averaging
- Set it and forget it investment approach
- Some company-sponsored plans offer discounts
- Commission-free share accumulation
- New funds are put to work immediately
- No issues with buying and holding fractional shares
- Loss of control over investment decisions
- May create portfolio imbalances
- Bad technique for short-term investors
- Lost access to your dividends
- Income taxes must still be paid
- More investment administration is required
- Some company-sponsored plans have fees
Regardless of what direction you decide to take. Thanks for reading!
And feel free to check out some of our other…
Thoughtful Guides To Dividend Investing
…before you go.
Author Bio: Tom Scott founded the consulting and coaching firm Dividends Diversify, LLC. He leverages his expertise and decades of experience in goal setting, relocation assistance, and investing for long-term wealth to help clients reach their full potential.