A dividend reinvestment program (known by the unfortunate acronym of DRIP) is another way of helping your money grow.
In essence, a DRIP is a savings account that offers compound interest. However, instead of accumulating cash over time, you accumulate stock instead. Some companies issue stock that pays dividends (a type of payment intended for the company stockholders) in the form of more stock than in dollars. DRIPs can be administered directly by the company or provided by broker trading stocks and bonds.
There are differences between various providers of DRIPs, which are worth knowing about to ensure you’re getting the best option for your money.
For example, let’s say that you’re looking into a company DRIP issuing a $200 dividend. It would be translated to the shareholder as $200 worth of stock. If the price of each share is $15, the investor will end up with 13.33 shares. Certain companies have a minimum number of shares an individual would need to own to 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 cannot 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 onset, they’re a cheap and easy way to buy and accumulate stock, and a great way for the more impulsive savers who could be tempted to fritter away a cash dividend on a weekend break.
From a company’s perspective, DRIPs are equally popular. They provide an effective way to distribute dividends to shareholders without having to use cash. Everyone’s a winner!
While DRIPs offer plenty of advantages to companies and shareholders, retail investors can also benefit from them as this program makes it cheaper to buy a stock share. Investors can use DRIPs to avoid the (often pricey) brokerage fees, and on top of this, companies sometimes 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 the stock at several different price points. It enables you to make the most of the investment-maximizing principle of dollar-cost averaging. By continuing to do so, you minimize the risk of buying stocks at peak prices.
Like everything else, there’s a downside to DRIPs, but it’s not as serious as you may think.
For most investors, the main irritation with DRIPs is that to register and apply for a company DRIP, you need a company’s stock certificate. This process may seem outdated, but it’s highly likely that it will charge you for the certificate. You need to ensure that the certificate is stored safely since it’s your only solid proof that you own the shares.
When it comes to selling the stock because you bought the stick at different price points, you will need to figure out the tax will be due on each, and that can cause some investors a bit of a headache. If you’re going to go in for DRIPs, we suggest you involve your accountant.