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Ask a Fool: Is Automatic Dividend Reinvestment Ever a Bad Idea?

Q: I've read a lot about the benefits of DRIP investing, but is it ever a bad idea to enroll stocks in a DRIP? 

Generally speaking, enrolling your stocks in a dividend reinvestment plan, or DRIP, is a good move.  

Dividend reinvestment offers some big benefits. DRIPs allow you to buy fractional shares, so your entire dividend is put to work. You typically don't pay any commissions for reinvesting your dividends. Plus, making the process automatic sets you up for maintenance-free compound returns. 

However, there are some situations where dividend reinvestment might not make sense. Here are two of the most common. 

The first is if you want the freedom to choose where your dividends are reinvested. When you're enrolled in a DRIP, your dividends are automatically used to buy more of the same stock, no matter how cheap or expensive it is. On the other hand, if you choose to receive all of your dividends in cash, you can use the entire amount to invest in whichever stock you feel is the best value at the time. 

The second is for tax purposes. If you own dividend stocks in a standard taxable brokerage account, your dividends are considered taxable income, even if you reinvest them. In other words, if you receive $1,000 in dividends and reinvest them, you'll still owe dividend taxes on that $1,000 of income even though you never actually received the cash. If you're worried about excess tax liability at the end of the year, it could be a smart idea to receive dividends in cash.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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