Pros and Cons of Dividend Reinvestment Plans

There are a number of different strategies that you can follow to improve the performance of your stock portfolio. One of the most touted options is dividend reinvestment plans (DRIPS). Are DRIPs actually decent investment ideas? Over 600 companies have raised their dividends over the past six years, so here are some things that you will need to consider.

Benefits of DRIPs

There are a number of reasons that DRIPs can be awesome investments. Here are some of the benefits that you should be aware of:

  • Avoid brokerage fees. Broker commissions and fees can be a major strain on your portfolio returns. Fortunately, you don’t generally need to pay them if you are investing in a DRIP.
  • Many companies offer discounts to customers purchasing new stocks through their DRIPs. The discount is usually between 2 and 5%.
  • Automate your scalability. One of the biggest reasons that people have trouble growing their money is that they aren’t dedicated enough to continually buy new shares of their preferred investments. Fortunately, you don’t need to worry about that while investing in DRIPs, because your earned dividends are automatically converted into new shares of stock.

There are clearly a number of compelling reasons to consider investing in dividend reinvestment plans. They are particularly popular among high-growth investors, because DRIPs tend to grow more quickly than other types of investment options.

Drawbacks to Consider

While there are clearly a number of great reasons to invest in DRIPs, there are also some drawbacks to be aware of. Make sure that you read the pitfalls listed below before committing to one.

Lack of Diversification

While many experts such as Jim Cramer feel that diversification is drastically overrated, there are still some compelling reasons to spread your portfolio across different assets. The biggest drawback with DRIPs is that you have to commit your earned dividends to the same stock. As a result, you will have a lot of money in that security, which can be a problem if it takes a dive.

Complicated Taxes

Many investors mistakenly believe that dividends aren’t taxable if they are reinvested, since they aren’t actually receiving cash. Unfortunately, the IRS isn’t as generous as they would like to believe. You still need to pay taxes on your dividends, unless your DRIP is part of an IRA. You also need to keep close track of the number of shares you are holding, because your dividends will increase as you purchase more shares of stock with them.

Lack of Services

Many companies don’t offer the support services that people often need while investing in DRIPs. You will need to be a more informed investor or consult with an expert to make sure that you are reaching your long-term financial goals. You can find a variety of investing experts at Alliance Financial that will be happy to assist you.