DIVIDEND REINVESTMENT PLANS

Dividend reinvestment plans (DRPs) are an extremely popular way to increase your holding in a particular stock without any additional out-of-pocket expenses. If the company was good enough to invest in the first time, wouldn’t it be a good company to invest in again? That’s the premise behind the DRP programs. DRPs allow the investor to reinvest automatically any dividends and capital gains into the stock, essentially swapping the monetary value of the dividends and capital gains for more shares of common stock. These plans are especially good for younger people who are seeking to accumulate capital, or for those people who don’t need the income that the dividends would provide.

DRPs are easy to set up, too. You can elect to reinvest the dividends at the time of the initial purchase, or later. The result is a longterm growth of capital, measured in the form of shares owned, as well as in total value. The only difference is that you are investing a little bit of money at a time after a larger initial purchase. In this way, DRPs are similar to dollar-cost averaging a mutual fund.

DRPs do have a couple of drawbacks, though. First, reinvesting your dividends isn’t a good idea if you rely on the income that they provide. If you find that you need that money, then you should opt to have the check come to you, rather than bve reinvested. Second, finding the appropriate cost basis is more difficult when you participate in a DRP. Should you want to sell your stock, you will want to know what kind of tax consequences you will face. Unless you have kept good records (which I believe is vital), it will be difficult to assess what your true basis is. However, if you don’t think you will be selling your stock, or you aren’t concerned about your cost basis, then this isn’t a concern for you, and a reinvestment program would probably be a good idea.

Essentially, the advantages of DRPs outweigh the disadvantages, depending on your circumstances. The fact that you can consistently increase your holding in a company’s common stock without spending any more money out of your pocket is a very enticing way to invest, isn’t it? Over time, the number of shares of stock that you own will have dramatically increased, and all you had to do was opt to have your dividends reinvested.