I've been investing in the stock market since college. I'm almost 40 now. There have been many parts of my investment strategy that have served me very well along the way. One of them is enrolling every stock I own in a dividend reinvestment plan, or DRIP.
In a nutshell, a DRIP allows my dividends to be automatically invested in new shares of the same stock. The entire dividend is invested. For example, if Apple (AAPL -0.10%) trades for $130 per share and my Apple position pays me a $50 dividend, it would be immediately used to add about 0.38 shares of Apple stock to my investment.
However, some of the biggest reasons to use a DRIP to automatically reinvest my dividends no longer apply. So, in 2021, I've decided to opt out of dividend reinvestment for the first time in more than 15 years. Here are my reasons.
Reason 1: Investing is free now
One of the biggest reasons I've historically been a proponent of DRIP investing is because it's commission-free. When brokers were charging $9.99 or more for every online stock trade, DRIP investments didn't cost a penny.
However, that was a different time. As we head into 2021, most online brokers have eliminated commissions for stock trading. If I receive a $50 dividend and my broker charges $10 commissions per trade, it wouldn't be practical to reinvest it. But now that trading is free, I don't need a DRIP to make dividend reinvestment practical.
Reason 2: You don't need a DRIP to buy fractional shares anymore
The other big reason to use a DRIP is that it allows you to purchase fractional shares. In other words, if your stock is trading for $20 per share and you receive a $50 dividend payment, a DRIP would use the money to buy 2.5 shares.
Until recently, this wasn't possible unless you used a DRIP. However, stock trading platforms like Robinhood pioneered the availability of fractional share investing. Some of the major brokers like Charles Schwab (SCHW -0.76%) have followed suit. In full disclosure, I use TD Ameritrade, which does not yet offer fractional share trading. But since TD Ameritrade was recently acquired by Schwab, it's just a matter of time before that feature makes its way over.
Reason 3: I'm starting to get hefty tax bills
One of the downsides to automatic dividend reinvestment is that your dividends are still considered taxable income -- but you don't have any cash.
In other words, if I receive a $100 dividend in my taxable brokerage account, that becomes taxable income at the end of the year. Dividends generally get lower tax rates than ordinary income, but it's still taxable at a significant rate in most cases (15% for me). This is true even though you never actually receive the cash with DRIP investing.
This wasn't much of a problem when I was first starting out. About a decade ago, dividend income might have added a hundred dollars to my tax bill. But now that I've been investing for a while, it's becoming more of an issue. Annual dividend income of $1,000 at my qualified dividend tax rate is $150 in taxes, $5,000 in dividends means $750 in tax, $10,000 adds $1,500 to my tax bill, etc. You get the idea. As your account grows, the impact of your dividends on your taxes increases. This is certainly a good problem to have, but by getting rid of automatic dividend reinvestment, I'm now free to set some of my dividend income aside for tax purposes.
Reason 4: I'm a stock picker
I've decided to opt out of dividend reinvestment largely because I like to choose my own stock investments. In today's market, I feel like there's value to be found for patient long-term investors like me.
Think of it this way. If I own 20 stocks and each pays me $50 in quarterly dividend income, by un-enrolling in automatic dividend reinvestment, I'm now free to take that entire $1,000 and invest it in the most compelling opportunities. That's exactly what I plan to do in 2021.
Should anyone keep using DRIP investing?
I'm not saying everyone should go ahead and un-enroll from their broker's DRIP. While some of the biggest reasons to use DRIP investing are gone, there's one big one that remains -- it makes the process automatic. Not every investor wants to research and choose individual stocks to invest their dividend payments in.
You don't have to keep track of what stocks are paying dividends on which dates and then figure out how many new shares you can buy. There is certainly value in making the reinvestment process automatic. Weigh this against the reasons for getting rid of DRIP investing before making your decision.