Dividend reinvestment (DRIP) | Robinhood (2024)

FAQs

Should I use DRIP to reinvest dividends? ›

If you are not dependent on your dividend income, consider letting it be used to cultivate your savings by enrolling in a DRIP; however, this investing technique may not be suitable to all investors. Check with your financial planner and a qualified tax advisor to determine what makes sense for your situation.

The IRS considers any dividends you receive as taxable income, whether you reinvest them or not. When you reinvest dividends, for tax purposes you are essentially receiving the dividend and then using it to purchase more shares.

The word DRIP is an acronym for "dividend reinvestment plan", but DRIP also happens to describe the way the plan works. With DRIPs, the cash dividends that an investor receives from a company are reinvested to purchase more stock, making the investment in the company grow little by little.

A significant benefit of a DRIP is that it enables you to buy more shares and build wealth over time. When you reinvest your dividends, your investment grows, and you earn even more dividends the next time—and so on.

Dividend reinvestment has some drawbacks. One downside is that investors have no control over the price at which they buy shares. If the stock gains significant value, they'd still buy shares at what could be a high price.

Options include owning dividend-paying stocks in a tax-advantaged retirement account or 529 plan. You can also avoid paying capital gains tax altogether on certain dividend-paying stocks if your income is low enough. A financial advisor can help you employ dividend investing in your portfolio.

Dividends are taxable regardless of whether you take them in cash or reinvest them in the mutual fund that pays them out. You incur the tax liability in the year in which the dividends are reinvested.

Dividends from stocks or funds are taxable income, whether you receive them or reinvest them. Qualified dividends are taxed at lower capital gains rates; unqualified dividends as ordinary income. Putting dividend-paying stocks in tax-advantaged accounts can help you avoid or delay the taxes due.

There are times when it makes better sense to take the cash instead of reinvesting dividends. These include when you are at or close to retirement and you need the money; when the stock or fund isn't performing well; when you want to diversify your portfolio; and when reinvesting unbalances your portfolio.

Which fund is better, growth or dividend reinvestment? ›

What is your risk tolerance? If you're more risk-averse, reinvesting dividends might be preferable since this strategy tends to be more stable and offers (some) predictability. If you are willing to trade having more risk for the possibility of higher returns, investing in growth funds will be more appealing.

By reinvesting your dividends back into the company, you can receive additional shares in return at a lower cost. This can help to boost your investment's value and performance over the long term. Additionally, owning a variety of stocks can help to mitigate risk in your overall portfolio.

Drawbacks of Dividend Reinvestment Plan (DRIP)

Minimum investments: Most DRIPs have a minimum investment requirement. This may be too costly for some investors, especially if you are starting. Fees: While many DRIPs don't charge commissions, some have associated costs.

Because shares are automatically purchased, investors may end up investing at a time when prices are on the higher end. Con: DRIP plans could throw your portfolio off balance. Overexposure to a particular company could hurt you in the long-run if your portfolio doesn't have a good mix of assets.

Simply purchase shares and fractional shares that reflect the dollar value of your dividend payment. If no fractional shares are available, hold onto the money until you have enough to buy whole shares. This DRIP process is more labor intensive, but you can still benefit from compound returns and dollar-cost averaging.

A simple and straightforward way to reinvest the dividends that you earn from your investments is to set up an automatic dividend reinvestment plan (DRIP), either through your broker or with the issuing fund company itself.

Your Money Will Grow Exponentially Thanks To Compounded Growth: Arguably the best advantage of dividend reinvestment is that it allows you to buy more shares of the same stock and build wealth over time. By purchasing more shares of the same stock with passive dividends, your investment grows further as you reinvest.

If you examine your returns 10 or 20 years later, reinvesting is more likely to increase the value of your investment than simply taking the cash. Also, reinvesting allows you to purchase fractional shares and get discounted prices.