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What Is Dividend Reinvestment Plan (DRIP)?

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by Beatrice Mastropietro · 7 min read
What Is Dividend Reinvestment Plan (DRIP)?
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Do you have investments? If so, then you should know about the DRIP reinvestment plan. This is a popular investment strategy used by many investors to grow their assets. In this guide, we will discuss how DRIP works and how to go about setting up your DRIP account.

A DRIP is a type of investment account that investors can use to buy shares in a company. It stands for Dividend Reinvestment Plan. It is an “automatic investing” method as you simply provide your bank information, tell the company how much money you would like to invest each month/week/year. They will automatically purchase additional shares on your behalf. DRIP reinvestment plan is great for those who want to control their investments but do not have time to follow the stock market every day.

In DRIPs, you can choose to reinvest your dividends in the company’s stock. DRIPs are different from other investment plans because they focus on buying and holding shares for long-term growth rather than trading them frequently for short-term gains.

Understanding DRIP

A dividend usually has a form of a check or direct deposit. A dividend reinvestment plan allows owners to utilize their dividends to buy more stock from the company. Shares acquired in this method are often non-liquid and may be redeemed only directly with the business.

One of the most common types of dividend reinvestment programs provides shares at a significant discount. But it is on the condition that you purchase them with a small fee rather than the total price and they require a minimum investment amount of $10. These programs usually target investors who already have shares in the company. However, some will accept new investors if their investment is more substantial.

Types of Dividend Reinvestment Plans

There are many ways to reinvest dividends, depending on your investment objectives. Some DRIPs do not provide any dividends for the first year. Others offer a little less than the issuing company pays out to shareholders generally. Besides, some will give one or two additional shares as rebates for every share owned after a specific time interval. In this way, some companies “reward” their loyal, long-term shareholders by giving them an extra share now and then or by increasing the number of shares they own overall over time because the dividend is directly reinvested rather than paid out.

There are several types of DRIPs:

  • Company-Operated DRIP Programs. Some large-cap companies offer their own direct stock purchase plans and dividends reinvestment programs (DRIPs) that allow you to buy stocks directly from them instead of using a brokerage, as well as traditional DRIPs that are available to buy in the public market.
  • Suggested Changes. A few large-cap company members of the DJIA have allocated a portion or all of their stock dividend payments for investors enrolled in their company’s direct knowledge purchase plan and who reside within the US via providing attractive discount shares acquired by enrolling. These firms include Coca-Cola Co. (NYSE: KO), Johnson & Johnson (NYSE: JNJ), Procter & Gamble (NYSE: PG), United States Steel Corp.
  • Third-party DRIPs. The best way to start investing is in third-party DRIPs, which are often offered by transferring agents. Computershare is one of the leading transfer agents and offers a search portal so that you can research and sign up for companies with DRIPs as well. Generally, there are fees associated with the amount of stock you want to invest in. In some cases, there are also fees with individual purchases. Comparison is essential when looking at your options. Some brokerages offer the opportunity to invest in stocks for more than one company and mutual funds or ETFs.
  • DIY DRIPs. If you are looking for a company that does not offer dividend reinvestment, or if your brokerage doesn’t allow it, it is possible to do it on your own. Fractional shares may be unavailable. However, you can still invest manually and continue to reap the benefits of compound returns or dollar-cost averaging.

How Does DRIP Work?

A DRIP reinvestment plan is a simple concept: invest all the dividends from stocks and index funds while buying new shares. Rinse and repeat as often as you wish.

However, it is not limited to whole stocks and is applicable to fractional shares as well. Fractional shares occur whenever a company issues dividends in excess of the number of shares owned by an investor. Fractional shares are generally worth less than one whole share and have no financial value. But they can serve as evidence that you own stock in a company. To redeem fractional shares for cash payment, you must contact the transfer agent or broker who processed your purchase when you made the first purchase on the stock market. Fractionals may not trade independently on any exchange. Therefore, they have no market value, although some security depositories will issue certificates carrying certain rights to fractionals. Fractional ownership occurs regularly within mutual funds, where such holdings are better known as undivided interests.

Advantages of a Dividend Reinvestment Plan

The benefits DRIPs provide for investors are numerous. Firstly, they include taxation advantages. This is mainly applicable if you have stocks from a US company as they have tax holidays every year and usually come together with dividend payments. Secondly, a DRIP allows the investor to buy stocks directly from the company without paying any commission or brokerage fees.

Further, a DRIP enables the investor to buy shares for only $25 per transaction, this amount will vary by the company. In addition, an investor can purchase more shares with the money received from the dividend payment.

Companies can take benefit from DRIPs as well. By using DRIPs, companies can raise cash to grow their businesses or cover shortfalls during tough economic times by encouraging investors to invest directly in the company rather than selling off stocks to get the money they need by offering them incentives such as lower fees. Moreover, the money for dividend payments that accrued while the company was not publicly traded remains with the company and is not paid out pro-rata to all shareholders.

Another advantage for companies is the collection of fees. In particular, the company charges fees directly itself. However, it will generally use its broker-dealer. Therefore, there will be some costs on account of commissions, exchange fees, etc., which other sources such as revenue from trading or other services performed for clients cover.

The Drawbacks of Using a DRIP

Despite numerous advantages, there are several drawbacks that DRIPs possess.

Firstly, there is no commission when investing in stocks purchased through dividend reinvestment plans. In contrast, a broker usually charges a 1% to 2% commission on each trade.

Further, the disadvantage of transactions costs adds up over time. An investor can save thousands of dollars in transaction costs by investing through a traditional brokerage account instead of a DRIP plan.

Finally, some companies may have their share price drop below the level when you bought the stock. If this happens, you will still buy your shares at a higher rate regardless of market prices.

How to Start DRIP Investing

A DRIP is a dividend reinvestment plan for buying shares of a company’s stock automatically. DRIP plans are common for companies that pay dividends as an alternative way for shareholders to purchase more shares at no additional cost and with little effort on their part.

Companies may offer DRIP programs because they want long-term investors to hold onto their stocks through various market cycles. These programs can also be useful when there is limited liquidity or when it would otherwise be cost- or time-consuming for a shareholder to acquire enough securities using other methods.

When looking for stocks to invest in, examine the company’s history of paying dividends. Even if they have not increased their dividend payout historically, a consistently reliable record is vital.

Once you’ve decided which companies to invest in, there are several options for DRIPs depending on the type of reinvesting. They include company-operated DRIP Programs, suggested changes, third-party DRIPs, and DIY DRIPs.

Conclusion

Above and beyond the following safety tips, a DRIP reinvestment plan also has tax implications. If you plan to take advantage of this investment program, consult a tax professional for specific information on how these investments relate to your tax situation.

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FAQ

What is DRIP?

A DRIP is a type of investment account that investors can use to buy shares in a company. It stands for Dividend Reinvestment Program. It is an “automatic investing” method as you simply provide your bank information, tell the company how much money you would like to invest each month (or week or year).

How does DRIP work?

DRIPs give investors the option to reinvest the cash dividend and purchase shares from the company.

What are the benefits of DRIPs for companies?

By using DRIPs, companies can raise cash to grow their businesses or cover shortfalls during tough economic times by encouraging investors to invest directly in the company rather than selling off stocks to get the money they need by offering them incentives such as lower fees. Moreover, the money for dividend payments that accrued while the company was not publicly traded remains with the company and is not paid out pro-rata to all shareholders.

Another advantage for companies is the collection of fees. In particular, the company charges fees directly itself, although it will generally use its broker-dealer and thereby incur some costs on account of commissions, exchange fees, etc., which other sources such as revenue from trading or other services performed for clients cover.

What are the benefits of DRIPs for investors?

The benefits DRIPs provide for investors are numerous. Firstly, they include taxation advantages. This is mainly applicable if you have stocks from a US company as they have tax holidays every year and usually come together with dividend payments. Secondly, a DRIP allows the investor to buy stocks directly from the company without paying any commission or brokerage fees. 

Further, a DRIP enables the investor to buy shares for only $25 per transaction, this amount will vary by the company. In addition, an investor can purchase more shares with the money received from the dividend payment.

What are the disadvantages of DRIPs?

Firstly, there is no commission when investing in stocks purchased through dividend reinvestment plans. In contrast, a broker usually charges a 1% to 2% commission on each trade.

Further, the disadvantage of transactions costs adds up over time. An investor can save thousands of dollars in transaction costs by investing through a traditional brokerage account instead of a DRIP plan.

Finally, some companies may have their share price drop below the level when you bought the stock. If this happens, you will still buy your shares at a higher rate regardless of market prices.

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