Company-Offered Dividend Reinvestment Plans
Many companies provide dividend reinvestment plans for their shareholders. The concept and mechanics are relatively simple. Each time the company pays a dividend; your dividend amount is used to buy additional shares instead of being distributed to you as a check.
Benefits of a dividend reinvestment plan:
- You end up owning more shares, somewhat “painlessly.” The steady purchasing of additional shares provides a “compounding” effect because each dividend will be on a larger number of shares you own. The plan also can provide a “disciplined” investing approach. It will happen every quarter (or whenever dividends are paid) and you may not even notice you are missing a few dollars you might have otherwise spent.
- There are no broker’s commissions on the purchase of the new shares.
- Because the reinvestments are made over time, you get a “dollar cost averaging” benefit on the purchase of new shares. Assuming the dividend remains constant, you acquire more shares when the market price is lower and fewer shares when the share price is higher.
- Some companies sell additional shares as part of their dividend reinvestment plan at a small discount (up to five percent) to the current market price. If your company does this, you get a small bargain on the additional shares your dividends purchase.
Some companies also provide a much larger benefit to shareholders by enabling them to make additional cash purchases of stock under the terms of their dividend reinvestment plan. Usually ranging from $10 to $10,000 per quarter, you may be able to buy more shares without a commission and, depending on the plan, at a small discount to the market price.
Potential negatives of a dividend reinvestment plan:
Keeping track of the tax basis of shares purchased through a dividend reinvestment plan can be complicated. The dividend payments, even though you don’t actually receive the cash, are still taxable and must be reported on your tax return. Each purchase (every dividend) made results in a different cost basis for the shares purchased and a different holding period. When you sell the shares, you must have the records supporting your basis and you have to be able to identify shares held for more and less than a year.
The other potential negative of owning shares through a dividend reinvestment plan can arise when you want to sell your shares. If you own shares through a brokerage account, you can call the broker and place a sell order and have it executed immediately. It may take longer for shares in a dividend reinvestment program to be sold. Some plans only execute transactions once a day, or even less often. It also may take a week or longer for the actual proceeds of a sale to reach you.
Participating in a dividend reinvestment plan is a wonderful way to acquire more shares in a company. The convenience and potential cost savings can mean a lot. However, before you decide to participate in a reinvestment plan, be sure you want to own more shares in that company.
This content has been provided by Practical Money Skills and is intended to serve as a general guideline.