Dividend reinvestment plans or DRIPs let you automatically reinvest any dividend payments from a stock back into shares of the stock itself.  Instead of receiving your dividend payments as cash, they’re instead used to buy partial shares of corporation stock to grow your underlying equity position.  Although dividend reinvestment plans can be a great option if the stock you hold offers is there are both pros and cons to a dividend reinvestment plan that you should consider.

Dividend Reinvestment Plans Pros
The main advantage of dividend reinvestment plans is that they’re a hands off way to increase your underlying position in a stock that’s paying you dividends.  For dividend investors who don’t yet need the cash from dividends as current income, this can be a great option to grow your exposure to a good company without incurring the trading costs associated with investing in the stock outside of a DRP.

By reinvesting dividends, you obviate the need to decide where to invest those dividend payments that hit your brokerage account every quarter.  You’re already decided that the dividend stock you purchased is a solid investment so dividend reinvestment plans let you automate additional purchases of the corporation’s stock – something you were likely to do anyway.

Add to these the fact that share purchase can be in partial shares which typically cannot be done outside a DRIP or a some other special partial share purchase program and that these trades incur no fees and no commissions to your broker and you can see why a dividend reinvestment plan is so popular.

Dividend Reinvestment Plan Cons
The primary disadvantage of dividend reinvestment plans is the fact that automatically reinvesting those cash dividends into the company that paid them might not be the best decision every time.  It’s very possible that some other stock outside your DRIP portfolio might be a better purchase with those dividend proceeds than the stock that generated them.  Especially for more active investors, investing regularly every quarter in the same group of dividend paying stocks might not represent the best return available at the time.

In addition, not every company offers dividend reinvestment plans for their stocks.  This isn’t necessarily a con about the plans themselves but about their appropriateness as a core part of your dividend investing strategy.  Having a portion of the stocks you own having dividends reinvested and the rest paying cash dividends which you then have to reinvest yourself takes away some of the ease of use and advantage of DRIPs.

Like compound interest, though, dividend reinvestment plans let you continue to build value in an asset you already own without lifting a finger after making the initial purchase.  This aspect of DRPs make them ideal for the investor who doesn’t want to have to worry about researching where to invest each dividend payment each quarter.

They come with the caveat that reinvesting dividends might not always be the most potentially profitable use of that cash but, considering that many dividend investors aren’t looking to take that active of a role in the day to day management of their portfolios, dividend reinvestment plans might be the perfect solution.