When you own certain stocks and most mutual funds, you can reinvest the dividends or distributions to buy more shares instead of receiving a cash payout.
In a corporate Dividend Reinvestment Plan (DRIP), for example, a company offers you the right to reinvest any cash dividends automatically to buy more stock. When you open a mutual fund account, you're generally offered an automatic reinvestment option as well.
One benefit of reinvestment programs is that in most cases you can make the new investments without incurring the usual sales charges, so it can be a lower cost way to build your investment portfolio.
One potential drawback, if you're reinvesting in a taxable account, is that you acquire shares at different prices, so figuring the cost basis for capital gains or losses when you sell can be more complicated than if you made fewer, larger purchases. It's also true that you owe income or capital gains tax in the year the money is reinvested, which isn't the case in a tax-deferred or tax-free account.
You will also want to consider the impact of reinvestment on the diversification of your portfolio, since buying additional shares increases the percentage of your portfolio that is allocated to a particular stock or mutual fund.
- Browse Related Terms: Capital gains distribution, Compounding, Direct investment, Direct purchase plan (DPP), Distribution, dividend, Dividend reinvestment plan (DRIP), dollar cost averaging, Fractional share, Growth, January Effect, reinvestment, total return, Total return index
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