Pros and Cons of Dividend Reinvestment Plans

Dividend reinvestment plans are commonly offered by companies as a way for stockholders to reinvest the dividends that are due to them in more stock from the company. This type of plan can provide several advantages for investors. At the same time, there are a few potential disadvantages of this type of investment plan. Here are some of the pros and cons of dividend reinvestment plans.

Cut Out Commissions

One of the biggest advantages of this type of investment plan is that you will be able to cut out the middleman. You will not be forced to buy stock through a stockbroker. Instead, you will be working directly with the company that issues the stock. This means that you can purchase stock from the company and you will not have to pay commissions. Over the long-term, this can add up to significant amounts of savings for you.

Compound Returns

Another advantage of this type of plan is that it allows you to compound your returns and build your portfolio quickly. When you receive a dividend from the company, it is based on the amount of shares that you own in the company. When you immediately put your dividends into purchasing more stock from the company, you will increase the number of shares that you own. The next time that a dividend is issued, it will be based on a larger amount of shares for you. This means that your dividend payment will be larger and it will allow you to purchase an even larger number of shares in the future. This allows you to compound your returns and build a big portfolio in a short amount of time.

Avoids Diversification

Even though dividend reinvestment plans provide you with a good way to purchase stock, they can lead to some problems. One of the biggest problems is that you will lack diversification. With this strategy, you are taking all of the money that you earn from the investment and putting it directly back into purchasing more of the same stock. Many people end up putting too much of their savings into one particular company. When this happens, they own a large number of shares in one company instead of diversifying their money over a large group of stocks. 

Choosing the Wrong Company

Another disadvantage of this strategy is that it requires you to choose a company that will be successful in the long-term. This provides you with a limited number of companies choose from. You have to choose a company that will be in business, and be strong enough to issue dividends on a regular basis. If you were to choose the wrong company, your plan would be devastated. You would not be able to receive regular dividends from the company in order to purchase more shares of stock. Eventually, the company could go out of business and all of the money that you have invested could be lost.

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