Dividend reinvestment plans, also known as DRIPs, allow you to put the income that you receive from stock dividends back into your investment, buying more full shares or fractional shares, instead of receiving the dividend amount in cash. A DRIP enables you to quickly reinvest your dividend dollars and to increase your investment in the stock market, but it also has pitfalls.
Personal Time and Records
You must maintain records for all transactions related to the DRIPs so that you have accurate figures for calculating your cost basis when you decide to sell those stocks, according to The CPA Journal. These records will be significant if you maintain multiple holdings in DRIPs for several years.
In addition, DRIPs are made in individual stocks. This requires investors to be active, keeping track of their stocks, staying on top of the extent of their investments in them, and weighing when to increase or decrease their holdings.
DRIPs do not allow you to make trades designed to anticipate changes in the market, according to The CPA Journal. When you reinvest your dividends through a DRIP, you are not choosing the price at which you will be buying your stock. So the timing of the new purchase could prove unfortunate, forcing you to buy a stock at a price from which it might fall.
A DRIP is a poor tool for short-term trades -- ones in which you plan to hold a stock for a brief time and then sell at an advantageous price. It takes several days to process trades related to DRIPs, preventing the kind of quick decisions on the market that fuel short-term trades.
One weakness of DRIPs is that they are not available for all stocks; each company decides whether to offer a DRIP program for its stock. Small, fast-growth companies often don't offer DRIPs, according to The CPA Journal. Also, some DRIPs charge fees, cutting into the value of reinvesting your dividend.
- MarketWatch: Three Advantages of Dividend Reinvestment Plans; Marshall Loeb; July 29, 2008
- "The Truth About Money"; Ric Edelman; 2005
- The The CPA Journal: Investment Opportunities Through Dividend Reinvestment Plans; J. Richard Williams and Debra Hall Oden; July 1997
- Investor.gov. "Stocks." Accessed May 16, 2020.
- DRIP Investor. "The Drip Answer Report." Accessed May 16, 2020.
- Brigham Young University. "22. Investing 5: Understanding Stocks," Page 465. Accessed May 16, 2020.
- Forbes. "Dividends and Dollar-Cost Averaging Provide Antidote to Bear Markets." Accessed May 16, 2020.
- DRIP Investor. "DRIP Investing Basics." Accessed May 16, 2020.
- Internal Revenue Service. "Frequently Asked Questions: Stocks (Options, Splits, Traders) 2." Accessed May 16, 2020.
- Internal Revenue Service. "Stocks (Options, Splits, Traders)." Accessed May 16, 2020.
Tom Gresham is a freelance writer and public relations specialist who has been writing professionally since 1999. His articles have appeared in "The Washington Post," "Virginia Magazine," "Vermont Magazine," "Adirondack Life" and the "Southern Arts Journal," among other publications. He graduated from the University of Virginia.