What are the pros and cons of a dividend reinvestment plan (DRIP)?

What are the pros and cons of a dividend reinvestment plan (DRIP)?

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June 2018

Chamberlain, Michael

Sacramento Santa Cruz Silicon Valley Davis, CA

First, so that there is no misunderstanding, let’s review "What is a DRIP"

DRIPs (Dividend Reinvestment Program) are offered by many companies to give shareholders the option of reinvesting the amount of a declared dividend by purchasing additional shares of that stock. Dividends are normally paid to the shareholders as a check or deposited to their account but with a DRIP the dividend is in the form of additional stock. The term DRIP is not considered the same as automatic reinvestment in a mutual fund.

There are several pros of a DRIP

  1. No commission on the sale of the stock.
  2. There can be a discount on the purchase price of 1-10%
  3. Out on sight and out of mind. You do not spend the dividends and you get compounding growth over time.
  4. Buying shares on a preset basis- sometimes high and sometimes low.

Contrary to others, I see some possible downsides.

I am a big believer in diversification in your portfolio and that by owning hundreds or thousands of companies (in Mutual funds or ETFs) there is less risk than by owning a handful of stock. Many people who buy individual stocks do not have adequate diversification of their portfolios. So, with DRIPs you are accumulating more shares of the same companies that you own and are not diversifying more. 

DRIPs are most common for US large stock companies. You should also have foreign developed, emerging markets and small cap stocks as well as fixed income holdings. If the only investing you are doing is the DRIPs then you will be getting out of balance.

I like using dividends to reinvest in the areas of the portfolio that are under-represented so that your allocation of the entire portfolio is closer to the ideal, as expressed in your investment policy statement.

June 2018
June 2018
June 2018
June 2018