What Is a Dividend Reinvestment Plan (DRIP)?

DRIP is an acronym that stands for dividend reinvestment plan. If you’re interested in investing, you may have come across the term DRIP investing. DRIP investing involves using dividends from a company to purchase more stock. Dividends are cash rewards that are provided for company shareholders. If a company uses DRIP programs, shareholders have the option to use their dividends to reinvest by purchasing more stock in the company. 

How DRIPs Work

DRIPs work by encouraging shareholders to use their cash dividends to reinvest in the company. This type of investment is designed to encourage business growth at the same time as rewarding shareholders. 

Dividend.com uses the example of a shareholder in Pepsi to outline how a DRIP plan works. In 1980, an investment of $2,000 would have secured 80 shares. By using a reinvestment program, the investor would have increased their number of shares to 2,800 by 2004. That initial investment of $2,000 ended up being worth more than $150,000. 

If you’re a shareholder in a company and you choose to participate in a DRIP scheme, you’ll receive cash rewards in the form of dividends. Your money will be paid either by check or a direct transfer. You, as the investor, then have the option to use your dividends to buy more stock.

How to Reinvest Dividends

There are two main options to choose from when reinvesting dividends:

• Setting up a DRIP account with the company
• Using a brokerage account

If you join a DRIP program with the company, you can purchase DRIP stock directly without the need to use a brokerage. Public companies operate DRIP plans at no cost to the investor. When you receive your dividends, you can buy DRIP shares from the company quickly and effortlessly.

Some companies offer flexible options for shareholders, including partial reinvestment. If you opt for partial reinvestment, this allows you to reinvest some of your dividends and divert the rest of your cash rewards to your checking account. 

If you use a brokerage account, you reinvest through a broker. Many of the leading brokerages provide a service free of charge. You can also benefit from automated features, which enable you to reinvest automatically. 

What Are Fractional Shares?

Many public companies offer investors the opportunity to purchase fractional shares. In this case, the dripping of dividends is not restricted to full shares. Fractional shares permit shareholders to invest in a portion of a full share. If a company paid a $10 dividend on DRIP stock with a trading value of $100, for example, every time the company paid dividends, the investor would receive 1/10 of a share. Fractional shares can be appealing to investors because they enable them to reinvest all their dividends in new shares. 

The Pros and Cons of Dividend Reinvestment

As with any type of investment, there are both pros and cons of dividend reinvestment. Here are the main points to consider if you’re thinking about investing in company-operated DRIPs. 

Advantages of Dividend Reinvestment

For investors:

• Opportunity to compound profits: If the DRIP stock value rises over time, investors have an opportunity to compound their profits, as their shares will be worth more.
• Simple, quick investment options: For shareholders, DRIP plans can be a simple, accessible, and quick means of reinvesting and buying stock. Today, you can automatically reinvest when you receive dividends and your DRIP account will run until you decide to close it. 
• Easy to get started: DRIP investing is an easy way to get into investing and buying stock. Whether you choose to buy directly from the company or use a brokerage, you can get started with minimal hassle. 
• Low or no trading fees: Many investors can now take advantage of free trading via online brokerages.
• Reduced risk through dollar-cost averaging: DRIPs use a method known as dollar-cost averaging to average out the price of stock. This means that you don’t buy shares at the highest or lowest price, which reduces risks for investors. 
• Flexibility: Many public companies offer shareholders a range of options, including full reinvestment, partial reinvestment, and the option of cash dividends. You can choose to pause reinvestment plans if you’d rather have the cash or you’d like to reinvest the money yourself. 
• Access to discounted stock: Some companies may offer investors access to discounts to incentivize DRIP investing. This means that shareholders can buy directly from the company and pay a lower DRIP stock price than they would on the open market.
• Alternative to online investing: Online investing is becoming increasingly popular, but it’s not for everyone. For people who would rather avoid online trading, DRIP investing may be an attractive proposition. 

For companies:

• Increased capital to reinvest: Companies that offer DRIP programs are able to earn capital, which they can reinvest in the business.
• Loyalty among shareholders: Shareholders who participate in DRIP programs are more likely to be loyal if the company goes through a bad patch or share prices drop slightly. 

Disadvantages of Dividend Reinvestment

• Some companies have minimum investment requirements: In many cases, DRIP plans can benefit small investors, but some companies do have a minimum investment requirement.
• Varied DRIP plans: DRIP programs vary from one company to another. If you’re interested in buying DRIP shares, it’s important to conduct thorough research first and make sure you understand the specifics of the program you want to join.
• Lack of flexibility with timing: Most companies reinvest dividends when the rewards are paid, which means that investors don’t have flexibility in terms of the timing of the reinvestment.
• Lack of portfolio diversity: The point of DRIP programs is to encourage shareholders to invest in the company by buying DRIP stock. If you want to invest in a different type of stock, you’ll need to arrange this yourself. Purchasing DRIP shares can contribute to a lack of diversity in your investment portfolio. 
• Dividends are taxable: if you reinvest your dividends, you’ll need to pay tax on the income you receive. 

Are DRIPs a Good Investment?

There are many advantages of DRIPs, and for some investors they can be very lucrative. DRIPs are considered a good investment option for people who don’t want to devote a huge amount of time and effort to trading, as well as those looking to amass income over time. It’s common to use DRIP investing to save funds for retirement.

Beginners can also benefit from accessing DRIP programs, as it is easy to get started, risks are reduced by using dollar-cost averaging, and there are opportunities to compound returns. 

DRIPs may not be viewed as the best type of investment for investors who already have an established portfolio and those who intend to live off their income from investing in stock. 

Getting Started with DRIP Investing

If you’re considering dividend reinvestment plans, the first decision you will need to make is to choose a type of plan. There are two primary options: using a brokerage and joining a company DRIP program. 

If you work with a brokerage, you may find that you have more options in terms of how you invest your money. You can reinvest in stocks and funds, and you may also be able to access fractional shares. If you reinvest through the company directly, you can only invest in stock that belongs to that specific organization. 

There may be differences between the ways in which brokerages work. If you’re looking to get involved in DRIPs, it’s wise to research brokerages and learn more about them before you decide which one to go with. In most cases, you can get started very quickly and complete all the tasks required to begin online.

If you wish to set up a DRIP account with a company, you can contact the investor relations department and they will tell you what to do next. Some companies don’t offer DRIP programs, but they do pay shareholder dividends. If this is the case, you can reinvest through your brokerage account. 

In Conclusion

Public companies often pay shareholders rewards in the form of dividends via a DRIP program. If you have a brokerage account or you join a DRIP program, you can reinvest your dividends by buying more of the company’s stock.