Reinvesting your earnings to keep your portfolio growing is always a smart move. That’s why many dividend stocks offer dividend reinvestment programs, or DRIPs, that automatically reinvest your dividends into more company stock. Many brokers have made it easy to set up automatic dividend reinvestments for your shares as well.
But dividend reinvestment programs aren’t nearly as useful in the age of free stock trading as they were when you had to pay the broker minimal fees for every trade you made. You can invest as little as 1 dollar in broken arrow No extra fees with lots of brokers. Therefore, the benefits of DRIP have been erased.
In fact, there may be downsides to using DRIP to reinvest your earnings. Here are three reasons not to do so.
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1. Would you rather use your dividends to pay for retirement expenses
If you plan to use the dividends your stock portfolio distributes to pay for your living expenses, you don’t want to reinvest your money in stocks. You want cold hard cash.
Creating a portfolio of big dividend payers and then living off the profits in retirement is a great way to build a fortune for generations. If you can live off the dividend payments and never have to sell your shares, then you can pass this stream of income on to your heirs. Furthermore, you will usually be able to determine your tax liability at the qualified dividend tax rate.
Although you may use DRIP to accumulate as many of your dividend stocks as you can while you work, you need to turn off the tap once you reach retirement. So, make sure you set things up to start receiving money once you retire.
2. You want to actively choose your best stock investment opportunities
If you use DRIP, the money will be automatically reinvested in stocks no matter what price they are trading at. But if you actively look for multiple stocks, you may see better opportunities to spread new money.
While shares were appleFor example, you may not sneeze anything, you may not want to buy more shares of the tech giant at the moment. Alternatively, you might look for stocks of another tech company with good earnings like Microsoftwhich offers the highest profit return It may be trading at a better price in your opinion.
Most importantly, even if you only own 10 shares of Apple and get $2.30 per quarter, most brokers will let you buy a partial share of Microsoft to reinvest those profits at no cost. The increased availability of $0 fee deals has removed one of the biggest benefits of DRIPs.
3. Want more control over your asset allocation
If you maintain a diversified portfolio, the dividends flowing into your account provide an opportunity to rebalance. Instead of reinvesting in the same asset, you can use the dividend to buy assets that are depreciating in value compared to the rest of your portfolio.
This also applies to individual stock investors. You may not want any single stock to become a heavyweight in your portfolio. But if you have a company that pays huge dividends, it may become a much larger part of your portfolio than you intended after several years.
Even if you take the cash and then decide to reinvest in the same asset, there is no additional cost to do so. By intentionally directing where you reinvest your earnings rather than automatically buying back the same shares, you will be able to make the most of your asset allocation decisions.
DRIP can be a great way to automatically reinvest your cash payments and help further grow your portfolio. But if you take a more active role in managing your portfolio, you can do a better job of using DRIP.
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Adam Levy He has positions at Apple and Microsoft. Motley Fool has and recommends positions at Apple and Microsoft. Motley Fool recommends the following options: long calls in March 2023 worth $120 on Apple and short calls in March 2023 worth $130 on Apple. Motley Fool has a profile Disclosure Policy.