DRIPs: The Pros and Cons of Dividend Reinvestment Plans
The acronym does not exactly conjure images of powerful investment strategies. That being said, DRIPs, or dividend reinvestment plans, can factor nicely into your financial planning strategy. Simply stated, these plans reinvest the paid dividends as opposed to receiving a cash payment. This can be very beneficial, depending on your individual goals, timelines, and overall strategies. As with any other tool, several factors must be taken into consideration to ensure that you are making the soundest decisions.
All About Timing
Depending on whether you are early in your investing career or approaching closer to retirement, will determine whether or not leveraging a DRIP makes sense. If your primary goal is to increase your holdings of a particular company, reinvesting your dividends is a powerful strategy. Many companies operate their own plans and offer discounts for shareholders who are utilizing dividend payments to purchase stock in their company. This is done by direct purchase as opposed to a secondary market. Audrey Arkins, a writer for Salary.com, explains, “More than 1,000 corporations offer Dividend Reinvestment Plans, from blue-chip companies like IBM, Chevron, and McDonald’s, to overseas firms such as British Telecom, Elf Aquitaine, and Sony. To get yourself started on one, choose from an extensive list and begin by purchasing your first shares” If you have the time and do not need the cash flow that your dividends would be paying you, this is an effective way to accumulate stock quickly.
Let’s say, however that you are no longer looking to grow your portfolio. You are actively in or nearing retirement and the income from your cash dividends is factoring into your monthly budget. DRIPs in this stage of the game are no longer an attractive nor viable strategic option as cash flow has become a more significant motivating force.
Risk and Reward
This is the stock market, after all, and risk is a player in the game. If your particular company is experiencing growth and doing well financially, you will see the benefits of a reinvestment plan pay out exponentially. However, if for some reason the company goes under, you will lose all of that money that was reinvested.
Things Can Get Complicated
With all of the transactions, fees, brokers, and institutions, record keeping is of paramount importance. This can be a bit confusing if you are attempting to keep track of your books yourself. Given this nature, it can also be a bit costly to have an outside firm to perform this function for you. This is however money well spent. The alternative to proper record keeping can be disastrous.
Dividend reinvestment plans can be a wonderful way to further your financial goals. As with any other investing strategy, however, it is important to perform thorough research and manage the process carefully throughout the entire life of your investments. This is particularly true as it pertains to the fees that can add up over the years of your investment.