Dividend Reinvestment Plans, or DRIPs, are programs that automatically invest cash from dividends into additional shares of the stock making those dividend payments.
Stock investors can enroll in DRIP programs as a way to take advantage of compounding returns, dollar-cost averaging and potential discounts on shares purchases.
Investors can sign up for DRIP programs through the public companies themselves, brokerage firms, or take on a do-it-yourself approach and reinvest dividends themselves.
Here’s a closer look on how to get started with DRIP investing.
Dividends are distributed payments of corporate profits to shareholders. Companies can reinvest profits into their businesses or divvy them for shareholders. When they do the latter, those payments are called dividends.
The majority of dividends are paid quarterly, so four times a year. But some stocks or exchange-traded funds (ETFs) pay dividends monthly or annually.
Some companies don’t make enough money to cover their expenses and pay shareholders dividends. Most companies that pay dividends tend to be larger and have stable, reliable businesses.
Some of the most popular and effective DRIPS are offered by Dividend Aristocrats. These are companies that have increased their dividend payouts every year for at least 25 years.
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How Do Dividend Reinvestment Plans Work?
When an investor buys shares in a company that pays dividends, those dividends normally get paid out as a direct deposit or check. If investors sign up for a DRIP program, they have the option to reinvest the dividends rather than receiving the payout.
The reinvested dividends go towards additional shares of the same stock. When the dividend cash is reinvested, it can sometimes go into buying fractional shares–slices of whole shares. DRIP programs also often use dollar-cost averaging, or the practice of spreading out investments and making periodic purchases in order to mitigate the effect of stock volatility.
Investors must still report the dividends as taxable income even though they don’t receive them. Investors will want to consult a tax expert.
Recommended: Paying Taxes on Stocks
Many times, additional shares in DRIPs are purchased directly from the company. Usually DRIP shares are issued directly from the company’s reserves and can’t be resold on a public stock exchange. Some brokerage accounts offer DRIP shares to investors—usually for free or a small fee.
Example of DRIP
The DRIP offered by Company X offers shareholders dividends of $1.76 per share each year, or $0.44 each quarter. Shareholders who take advantage of the DRIP reinvest that money into more Company X shares.
If a shareholder owns 100 shares of Company X, they receive $44 in dividends every quarter. If Company X’s stock price is $88, the dividend reinvestment will buy the investor half of one share of stock.
For investors, participating in company DRIPs can be advantageous, especially when companies offer shares at a discounted rate. Some companies hire outside firms or transfer agents to run their DRIP.
Companies that offer DRIP shares can use the money from shareholders into growing their business. Also, DRIP shares are less liquid than regular shares since they can’t be sold on a public stock exchange. This means investors are more likely to hold onto the shares.
Shareholders in DRIPs tend to be stable, long-term stock holders, since they are using the program to grow their portfolio and have chosen to enroll in the plan with that particular company.
Online brokerages DRIPs can be easier for investors looking to invest in multiple stocks. Shareholders can choose to enroll in DRIPs for all of their investments or just for select companies.
Some of the key advantages of DRIP programs used to be zero-commission stock purchases and the ability to buy fractional shares. But these days, many brokerages offer zero commission trading and fractional shares.
One disadvantage may be that brokerages don’t offer shares at a discounted level as company DRIPs do.
Pros and Cons for Investors
There are a number of reasons investors choose to reinvest their dividends through a Dividend Reinvestment Plan, and several reasons companies choose to offer them.
Pros for Investors
• Discounted Rate: Discounts on DRIP shares can be anywhere from 1% to 10%. Investors can also purchase fractional shares through DRIPS. This is useful because dividends payments may not be enough to buy an entire share of the stock.
• Zero Commission: DRIP programs can allow you to buy new shares without paying commission fees. However, many brokerages offer zero-commission trading outside of DRIPs these days.
• Fractional Shares: DRIPs may allow you to reinvest into fractional shares, rather than whole shares that may be at a pricier level than you wish to purchase.
• Compounding Returns: If an investor buys an asset which pays out interest or dividends, and then they reinvest those earnings into buying more of the asset, they are then earning on both their initial investment and on the interest. This is how compound interest grows investments.
• Automated Purchases: Investors can set up automatic reinvestment of their dividends into DRIP shares so they don’t even have to think about it after the initial set up.
Cons for Investors
• Less Liquid: DRIP shares aren’t as liquid as normal shares and can often only be sold back to the company directly. This means it will be difficult for an investor to quickly sell off shares.
• Need to Monitor: If an investor sets up automated DRIP investing, it can be easy to forget about the investment and not monitor it closely. Although the DRIP investment may be attractive at first, over time the market can change and the investor may want to allocate their money elsewhere, rebalance, or further diversify their portfolio.
• Limited Diversification: Investors sometimes use dividend income to invest in new stocks, but with DRIP investments they must invest the money back into more of the same stock. This further prevents portfolio diversification.
• Tax Reporting: Finally, figuring out tax reporting can be complicated with DRIPs. Investing in an IRA or using a brokerage account can help keep track of DRIP transactions. Again, consult a tax professional.
In order to start earning with the DRIP method, investors must first own shares of stock in companies that offer dividend reinvestment. The share or shares must be owned in the investor’s name, not a broker’s name.
Since there are hundreds of companies to choose from, it can be challenging to figure out which DRIP is the best. SoFi Invest® offers a full suite of investment tools in an easy to use mobile app. Using the Active Investing platform, you can buy company stocks, ETFs and fractional shares, while electing to participate in available DRIP programs.
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