3 reasons why you should avoid dividend reinvestment programs

(Adam Levy)

Reinvesting your dividends to keep growing your portfolio is always a smart move. That’s why many large dividend stocks offer dividend reinvestment programs, or DRIPs, which automatically reinvest dividends into multiple shares of the company. Many brokers have made it easy to create automatic dividend reinvestments for your stocks as well.

But dividend reinvestment programs aren’t as useful in the era of free stock trading as they were when you had to pay your broker a minimal fee for every trade you made. You can invest up to $ 1 in fractional stocks with no additional fees with many brokers. Hence, the benefits of a DRIP have been canceled.

In fact, there may be disadvantages to using a DRIP to reinvest your dividends. Here are three reasons not to.

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1. You would rather use your dividends to pay for your retirement expenses

If you plan to use the dividends your equity portfolio distributes to pay for your living expenses, you don’t want to reinvest your money in stocks. You want cold cash.

Creating a large dividend portfolio and then living off retirement dividends is a great way to build generational wealth. If you can live off dividend payments and never have to sell your shares, you can pass that stream of income to your heirs. Additionally, you will usually limit your tax liability to the qualifying dividend tax rate.

Although you can use a DRIP to accumulate as many shares of your dividend stocks as possible as you work, you need to turn off the tap once you reach retirement. So, make sure you set things up to start receiving cash once you retire.

2. You want to actively select your best equity investment opportunities

If you are using a DRIP, the money is automatically reinvested in a stock, regardless of the price at which it is traded. But if you are actively researching more stocks, you may see better opportunities to distribute new liquidity.

While the actions of apple, for example, it may not be anything to sneeze at, you may not want to buy more stock of the tech giant right now. Instead, you could look at the stock of another tech company with a good dividend like Microsoftwhich offers a higher dividend yield and can be traded at a better valuation, in your opinion.

Importantly, even if you only own 10 shares of Apple and receive a whopping $ 2.30 per quarter, most brokers will allow you to buy a fractional share of Microsoft to reinvest those dividends at no cost. The increased availability of $ 0 commission trades removed one of the biggest benefits of DRIPs.

3. You want more control over your asset allocation

If you are maintaining a diversified portfolio, the dividends flowing into your account offer an opportunity to rebalance. Instead of reinvesting in the same business, you can use the dividend payment to buy assets that have lost value relative to the rest of your portfolio.

This also applies to individual equity investors. You may not want any single stock to become too heavily weighted in your portfolio. But if you have a company that pays a high dividend, it could become a much larger part of your portfolio than you thought after several years.

Even if you take the cash and then decide to reinvest in the same asset again, there are no additional costs to do so. By purposely indicating where to reinvest your dividends instead of automatically repurchasing the same shares, you will be able to take full advantage of your asset allocation decisions.

A DRIP can be a great way to automatically reinvest your cash payments and help maximize the growth of your portfolio. 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 has positions and advises Apple and Microsoft. The Motley Fool recommends the following options: March 2023 $ 120 long calls on Apple and March 2023 $ 130 short calls on Apple. The Motley Fool has a disclosure policy.

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