We love it when things have an upwards trajectory, and investment and savings should be all about hitting those targets and achieving those goals. A dividend reinvestment program (known by the rather unfortunate acronym of DRIP) is another way of helping your money grow. Want to know more? Of course, you do!
In essence, a DRIP is a savings account that comes with the benefit of compound interest. However, instead of accumulating cash over time, you will accumulate stock instead. How? Well, some companies issue stock which pays dividends (a type of payment intended for the company stockholders) in the form of more stock, rather than in dollars. DRIPs can be administered directly by the company, or can also be provided by a brokerage trading stocks and bonds. However, there are some differences between various providers of DRIPs, which are worth knowing about to ensure you’re getting the best option for your money.
Let’s say, for example, that you’re looking into a company DRIP which is issuing a $200 dividend. This would be translated to the shareholder as $200 worth of stock. If the price of each share is $15, the investor should be end up with 13.33 shares. Certain companies have a minimum number of shares an individual would need to own instead of take part in a DRIP, while others would only need you them to own one.
The main benefit of brokerage DRIPs for most investors is an obvious one: they’re often much easier to set up and get started. However, it could be argued that these aren’t ‘true’ dividend reinvestments, simply because a brokerage is not able to issue a fraction of the stock in the same way a company can. If we look at the same previous example, the brokerage will take on your $200 dividend, and that $15 stock price would get you 13 shares. The remaining $5? That would be issued to you in cash instead.
From an investor’s point of view, DRIPs come with lots of advantages. From the offset, they’re a cheap and easy way to buy and accumulate stock, and they’re also great for the more impulsive savers among us who’d be tempted to fritter away a cash dividend on a weekend break, a nice new suit, or that watch you’ve had your eye on for a while…
From the perspective of a company, DRIPs are equally popular. They’re effective ways of them handing out dividends to their shareholders, without having to use cash. Everyone’s a winner!
As we’ve seen, there’s plenty of positive things to say about DRIPs, and their advantages benefit both sides of the same coin. However, there’s even more good news about these programs for you to consider. For retail investors, for example, DRIPs are popular because this program makes it cheaper to buy a share of stock. Investors are able to use DRIPs to avoid the (often pricey) brokerage fees, and on top of this, companies often even offer their shares to investors enrolled in DRIPs at an even more tempting discounted rate. Why? Simply because they allow the company to hold on to their cash by offering additional stock instead.
Here’s another benefit for you: When you reinvest, DRIPs allow you to buy stock at several different price points. What this means is that by investing in this way, you’re making the most of the investment-maximizing principle of dollar-cost averaging, and as you continue doing so, you’re making the risk of buying stock at peak prices consistently smaller.
We’re more than happy to sing the praises of DRIPs, as with anything in life, there’s always a couple of negative points to keep in mind. Thankfully, DRIPs don’t have many of these, and the positives easily outweigh them.
For most investors, the main irritation with DRIPs is that to register and apply for a company DRIP; you will need to get your hands on a stock certificate from the company. It is a process that can often seem somewhat outdated, and it’s highly likely that the company will charge you for the certificate. If you’re an absent-minded sort of investor, you’re going to have to make sure you keep it in a safe place – after all, it’s solid proof that you own the shares.
Also, when it comes to selling the stock, you have to be prepared to sit down and do some calculations. It can be tricky – after all, you will have bought the stock at lots of different prices, and figuring out how much tax will be due on them can cause some investors a bit of a headache. If you’re going to go in for DRIPs, may we suggest you have a friendly accountant on speed-dial… just in case it all gets too much!