Dividend Reinvestment Plans (DRIPs): Compounding Returns with Regular Payouts

August 18, 2023
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Dividend reinvestment is a tempting approach that can boost your investment returns. How? Let’s find out. 

What is a dividend reinvestment plan

So what is drip in simple terms? A dividend reinvestment plan is a program offered by a certain business that allows investors to automatically reinvest their cash dividends into additional shares or fractional shares of the underlying stock. With DRIPs traders are able to purchase more shares, thus compounding their investment over time. 

It can be a powerful tool for long-term investors seeking to grow their investment in a particular company steadily. However, investors should carefully consider their financial goals, tax situation, and preferences before enrolling in a DRIP or opting for traditional dividend payments.

Types of DRIPs

There are two main types of DRIPs:

  • Company-Run DRIPs. These DRIPs are directly administered by the company in which you own shares. Companies set up these plans to encourage long-term investment and loyalty among their shareholders. With a company-run DRIP, shareholders can automatically reinvest their dividends to purchase additional shares, often at a discounted price or without fees.
  • Brokerage-Run DRIPs. These DRIPs are facilitated by brokerage firms on behalf of the companies that offer dividend reinvestment plans. If a company does not have a direct DRIP program, some brokerage firms may offer DRIP options to their clients. In this case, the brokerage handles the reinvestment process and may charge a small fee for each reinvestment.

It's worth noting that not all companies offer DRIPs, and even among those that do, the specific features, benefits of the plans, and payment methods can vary. For instance, a spy dividend is held in cash until paid out quarterly. 

How does DRIP work

Firstly, to participate in a DRIP, you need to be a shareholder of a company offering such a plan. Some companies may have specific requirements for participation, such as a minimum number of shares or a certain holding period. You may need to enroll in the DRIP either directly through the company (for company-run DRIPs) or through your brokerage firm (for brokerage-run DRIPs).

When the company declares a dividend, your dividends are automatically reinvested into additional company shares. The number of shares that you purchase with your dividends will depend on the stock price on the dividend payment date.

With time, you can continue reinvesting your dividends until you decide to sell your shares. You can also choose to stop reinvesting your dividends at any time.

Benefits of using dividend reinvestment plans 

There are several benefits to using dividend investing:

  • Accumulating shares more quickly. When you reinvest your dividends, you are essentially buying more company shares with your own money. It helps to accumulate shares quicker.
  • Saving money. Many companies offer a discount on the purchase of shares through their DRIPs. It saves you money on the purchase of shares, which can increase your returns over time.
  • Convenient way of investing. DRIPs are a convenient way to invest because they automatically reinvest your dividends for you. So you do not have to remember to reinvest your dividends, and you can focus on other aspects of your investment portfolio.
  • Additional benefits. Some companies offer additional benefits to DRIP participants, such as early access to IPOs or discounts on other products or services.

Overall, DRIPs can be a good way to accumulate shares of a company and build a larger position in the company. It is important to note that drip stock investment is generally geared towards long-term investors who wish to reinvest their dividends and compound their holdings over time. However, they might not be suitable for all investors, especially those who rely on dividend returns for immediate financial needs. As with any investment decision, it's essential to consider your intentions if you're unsure about whether a DRIP will work for you.