3 Reasons Why You Should Avoid Dividend Reinvestment Programs | Economic news
Reinvesting your dividends to continue to grow your portfolio is always a smart move. That’s why many high-dividend stocks offer dividend reinvestment programs, or DRIPs, which automatically reinvest your dividends in more shares of the company. Many brokers have also made it easy to set up automatic dividend reinvestments for your stocks.
But dividend reinvestment programs aren’t as useful in the age of free stock trades as they were when you had to pay your broker a minimum fee for every trade you made. You can invest as little as $1 in fractional shares at no additional cost with many brokers. Thus, the advantages of a DRIP have been erased.
In fact, there may be downsides to using a DRIP to reinvest your dividends. Here are three reasons not to.
1. You prefer to use your dividends to pay your retirement expenses
If you plan to use the dividends distributed by your stock portfolio to pay your living expenses, you don’t want to reinvest your money in stocks. You want cash.
Building a portfolio of heavy dividend-payers and then living off the dividends in retirement is a great way to build generational wealth. If you can live on dividends and never have to sell your shares, you can pass that income stream on to your heirs. In addition, you will generally cap your tax payable at the qualifying dividend tax rate.
Although you can use a DRIP to accumulate as many shares of your dividend-paying stocks as possible while you work, you must turn off the tap once you reach retirement. So be sure to put things in place to start receiving money once you retire.
2. You want to actively pick your best stock investment opportunities
If you use a DRIP, the money is automatically reinvested in a stock, regardless of the price at which it is trading. But if you actively seek out multiple stocks, you may see better opportunities to deploy new cash.
While the actions of Apple, for example, might not be something to sneeze at, you might not want to buy more shares of the tech giant right now. Instead, you might be looking for shares of another tech company with a good dividend like Microsoftwhich offers a higher dividend yield and may trade at a better valuation, in your view.
Crucially, even if you only own 10 shares of Apple and receive $2.30 per quarter, most brokers will let you buy a fractional Microsoft share to reinvest those dividends at no cost. The increased availability of $0 transactions has removed one of the biggest advantages of DRIPs.
3. You want more control over your asset allocation
If you maintain a diversified portfolio, the dividends paid into your account provide you with the opportunity to rebalance. Instead of reinvesting in the same asset, you can use the dividend payment to buy assets that have fallen in value relative to the rest of your portfolio.
This also applies to individual stock investors. You may not want a single stock to become too heavy in your portfolio. But if you have a company that pays a large dividend, it could become a much larger part of your portfolio than you expected after several years.
Even if you take the money and then decide to reinvest in the same asset, there is no additional cost to do so. By deliberately directing where you reinvest your dividends rather than automatically repurchasing the same shares, you can get the most out of your asset allocation decisions.
A DRIP can be a great way to automatically reinvest your cash payments and maximize your portfolio growth. But if you take a slightly more active role in managing your portfolio, you can do better than using a DRIP.
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Adam Levy has positions at Apple and Microsoft. The Motley Fool holds posts and recommends Apple and Microsoft. The Motley Fool recommends the following options: long calls $120 in March 2023 on Apple and short calls $130 in March 2023 on Apple. The Motley Fool has a disclosure policy.