What is a Dividend Reinvestment Plan?
A dividend reinvestment plan (DRIP) is a program that lets you reinvest cash dividends back into a company.
You might hear the term DRIP used to refer to any automatic reinvestment arrangement, but generally it refers to a formal program offered by a publicly traded company to its shareholders.
How does a dividend reinvestment plan work?
When an investor owns dividend paying stocks, cash dividends are typically paid in the form of a check or direct deposit into the shareholder's account.
A DRIP gives you the option of automatically reinvesting that amount by buying additional shares of the company’s stock. Most companies give you the option of purchasing full or fractional shares.
Most company’s allow investors to buy these shares commission-free, or for a smaller fee than say from a brokerage firm. You will usually get a significant discount on the current share price.
Some DRIPs set minimum dollar amounts and may not allow reinvestments that are less than $10.
How DRIPs can work for you
With a dividend reinvestment plan, you can add more shares to your portfolio without paying commission fees and at a price that’s less than the current market value. Many companies offer shares at anywhere from 1% to 10% of the market value.
Since you’re paying nothing in commission and less than market value, your purchasing power is much stronger. In short, you get more for less.
How to reinvest dividends
You can usually enroll in an automatic dividend reinvestment program through your brokerage account. Normally, you’ll have three options when it comes to reinvesting:
- Automatically enroll all current and future stocks and funds
- Enroll all current stocks and funds
- Select individual stocks and funds
The first option is essentially a “set it and forget it” type of program. Any new stocks and funds will automatically be added to the reinvestment plan once they enter your portfolio.
Additionally, when a company pays a dividend, it will automatically be reinvested, since this option includes all current and future funds.
If you choose the second option, you’ll have to manually add any new stocks or dividend payments that you want to be included in the program.
When selecting a reinvestment plan, you should consider your options. If full automation if what you want, and you’re confident that you want all future funds to be reinvested, the first option is probably the right way to go.
However, if you’d like more control and less automation over your portfolio, the second or third options are probably right for you.
Remember, you can change the program if you'd like. If you choose full automation, that doesn't mean you're stuck with it for the life of your investment portfolio.
Want to know the current yield on your investment portfolio? Use our investment calculator to find out.
Before you invest
A dividend reinvestment plan can seem like an attractive option. Before you enroll in one, though, be sure that it’s right for you. Talk to your financial advisor and do your own research.
Before you start investing in the stock market, it's wise to make sure you have a solid monthly budget in place, have an emergency savings fund, and fully understand the risks involved.
Investing wisely in the stock market could generate financial gains in the long run. Uninformed investing, however, could cost you.
Take advantage of our free online financial education courses to help you better understand investing.