Key Considerations

DRIPs are very beneficial to help build up wealth if the company has substantial gains over time. For example, if you had $2,000 invested in Pepsi in 1980, that would be worth more than $150,000 by the end of 2004. You would have started with 80 shares, but by reinvesting dividends, you’d now have 2,800 shares:

The opposite is also true, if a company goes under then an investor will lose the money reinvested, never seeing the benefits of the dividend payouts. This is the risk and reward basis of investing. Investors need to always keep the pulse of the company that they are invested in to make sure they come out on top.

Another key consideration about DRIP investing is that if an investor does not need the cash dividend a company pays immediately, then a DRIP is an acceptable alternative to traditional dividends. However, if a steady dividend payment is needed as a source of income, then a DRIP is not an efficient way to manage dividends. DRIPs are a way to build up additional shares over time for a potential payoff in higher capital gains. Investors also need to be aware that the dividends that are reinvested are still seen as a source of income and therefore taxable. That’s right — just because you decide to automatically reinvest the dividends, never receiving any cash, Uncle Sam still gets his cut. Learn more about dividend taxation in A Brief History of Dividend Tax Rates .

Also, depending on what kinds of DRIPs an investor is involved with, it can be hard to track all of the transactions and purchases that have occurred over the years. The DRIP information could be spread out over several companies,transfer agents, or brokers, rather than in a single online brokerage account file. Extensive records need to be kept by an investor to maintain the proper information to help with income and tax related questions that might come about down the road. Keeping track of these records can be time consuming, or costly if done by an outside source such as an accountant. More problems could arise if the DRIP is with a company that is merged, sold, or involved in restructuring that can bring uncertainty to investors.

Shares bought in DRIPs are usually not easy to liquidate. Many times investors can not immediately sell at market price. It is not as easy as just calling a broker or hitting a button. Investors need to take into consideration the time it might take to sell off shares and at the price at which the sale will take place.

The Bottom Line

DRIPs are a nice alternative to the traditional dividend cash payout. However, an investor needs to be ready to put in the research and work to determine if a DRIP is the optimal investment strategy. DRIP investing can bring a change of pace and potential diversification to a portfolio, but it can result confusion and high costs if not properly managed. An investor just needs to take into account their needs and expectations of their investments to determine if a dividend reinvestment plan is right for them.