Ask a Fool: Should I Reinvest My Dividends?

By Matthew Frankel Markets Fool.com

Q: I just bought my first dividend stock. Should I enroll in a dividend reinvestment plan?

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There's no one-size-fits-all answer to this question, but I'm generally a big fan of dividend reinvestment plans (DRIPs) and enroll every dividend stock that I buy.

As the name implies, a DRIP is designed to allow investors to use their dividends to purchase additional shares of stock. Enrolling your stocks in a DRIP is usually a matter of a quick online form through your broker. If you enroll, when your stock pays a dividend, the DRIP will automatically use the payment to buy more shares of that stock at the current market price.

There are several advantages to using a DRIP:

  • Your dividend income is put to work for you immediately. The dividend never even shows up in your account -- it just buys additional shares right away.
  • You won't pay any trading commissions when your dividends are automatically used to buy more shares. Based on a $6.95 brokerage commission and quarterly dividends, this can save you nearly $28 per year per stock.
  • A DRIP allows you to buy fractional shares of stock, allowing you to invest 100% of your dividend payment every time. For example, if a stock trades for $100, and you own enough shares to receive an $80 dividend payment this quarter, a DRIP allows you to buy 0.8 of a share to add to your position, when you otherwise wouldn't be able to buy any at all.

Of course, if you rely on your dividend stocks to generate income, it's probably smarter to just let the cash dividends get deposited into your account. And if you own your dividend stocks in a taxable account, your reinvested dividends can still be taxed, just like if you had gotten them in cash.

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In a nutshell, I believe the benefits of a DRIP greatly outweigh the drawbacks, and if you're not planning to use your dividend income to pay your living expenses, I suggest enrolling your stocks in your broker's DRIP.

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