A dividend reinvestment plan (DRIP) is a program that allows investors to reinvest their cash dividends into additional shares or fractional sharesof the underlying stock on the dividend payment date. Although the term can apply to any automatic reinvestment arrangement set up through a brokerage or investment company, it generally refers to a formal program offered by a publicly traded corporation to existing shareholders. Around 650 companies and 500 closed-end funds currently do so.
Key Takeaways
A dividend reinvestment plan, or DRIP, automatically uses the proceeds generated from dividend stocks to purchase more shares of the company.
This strategy allows investors to compound their returns over time by accumulating more shares, which themselves pay dividends that will be reinvested.
Note that dividends paid into DRIPs are taxed as ordinary dividends even though they are used to purchase shares.
Normally, when dividends are paid, they are received by shareholders as a check or a direct deposit into their bank account. DRIPs, which are also known as dividend reinvestment programs, give shareholders the option of reinvesting the amount of a declared dividend into additional shares, which are bought directly from the company. Because shares purchased through a DRIP typically come from the company’s own reserve, they are not marketable throughstock exchanges. Shares must be redeemed directly through the company, also.
Most DRIPs allow investors to buy shares commission-free or for a nominal fee, and at a significant discount to the current share price; they may set dollar minimums. However, most do not allow reinvestments much lower than $10. While DRIPs are usually intended for existing shareholders, some companies do make them available to new investors, usually specifying a minimum purchase amount.
Although the shareholder does not actually receive the reinvested dividends, they still need to be reported as taxable income (unless they are held in a tax-advantaged account, like an IRA).
While most DRIPs use the cash proceeds from dividends to purchase additional shares, more complex methods can occur if the dividend itself is granted in stock in lieu of cash.
There are several advantages of purchasing shares through a DRIP, for both the company issuing the shares and the shareholder.
Advantages for the Investor
DRIPsoffer shareholders a way to accumulate more shares without having to pay a commission. Many companies offer shares at a discount through their DRIP from 1% to 10% off the current share price. Between no commissions and a price discount, the cost basis for owning the shares can be significantly lower than if the shares were purchased on the open market. Through DRIPs, investors can also buy fractional shares, so every dividend dollar is really going to work.
Long term, the biggest advantage is the effect of automatic reinvestment on the compounding of returns. When dividends are increased, shareholders receive an increasing amount on each share they own, which can also purchase a larger number of shares. Over time, this increases the total return potential of the investment. Because more shares can be purchased whenever the stock price decreases, the long-term potential for bigger gains is increased.
Advantages for the Company
Dividend-paying companies also benefit from DRIPs in a couple of ways. First, when shares are purchased from the company for a DRIP, it creates more capital for the company to use. Second, shareholders who participate in a DRIP are less likely to sell their shares when the stock market declines. Partly that's because participants tend to be long-term investors and recognize the role their dividends play in the long-term growth of their portfolios. Of course, another factor is that DRIP-purchased shares are not as liquid as shares purchased on the open market—they can only be redeemed via the company.
Most DRIPs, such as the one discussed here, are sponsored by a company (issue-sponsored) through their transfer agent, who holds the shares. Note that some brokerages allow customers to participate in a transfer agent DRIP while keeping the shares at the brokerage firm. In a broker-sponsored DRIP, the broker buys the share using the dividend proceeds in the open market.
Real-World Example of a DRIP
The 3M company offers a DRIP program. Administered by the company's transfer agent, EQ Shareowner Services, it gives registered shareholders the option of using all or a portion of their dividends (designated either by dollar percentage or by number of shares) to buy shares; if they don't choose an option when they enroll in the plan, all their dividends will be reinvested. The company pays all fees and commissions.
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Answer: A DRIP is a program offered by companies that allows shareholders to automatically reinvest their cash dividends into additional shares of the company's stock, helping to grow their investment over time.
What is a Dividend Reinvestment Plan (DRIP)? A Dividend Reinvestment Plan (DRIP) is a program that allows shareholders to automatically reinvest their cash dividends into additional company shares.
A DRIP established at a company doesn't offer the same cost benefits over a brokerage that it used to, so those looking to reinvest dividends are probably better off turning to their brokerage. Still, if a company's DRIP plan lets you buy stock at a discount to its market value, that can be an attractive incentive.
If customers choose to reinvest the money, they get cash dividends from the corporation. They will still be responsible for paying taxes on all those amounts. But if the business reinvests its dividends to buy more shares, it won't have to pay taxes until they sell them. Thank you.
When you reinvest dividends, for tax purposes you are essentially receiving the dividend and then using it to purchase more shares. So even though the dividend doesn't pass through your hands in cash form, it's still considered taxable income.
A significant benefit of a DRIP is that it enables you to buy more shares and build wealth over time. When you reinvest your dividends, your investment grows, and you earn even more dividends the next time—and so on.
Dividend reinvestment has some drawbacks. One downside is that investors have no control over the price at which they buy shares. If the stock gains significant value, they'd still buy shares at what could be a high price.
Of course, you would be moving the decimal over and only buying whole shares, but this is for simplicity. Compounding Effect: This process repeats each year, with Buffett owning slightly more shares and thus earning slightly more in dividends, which he continues to reinvest.
Not reinvesting dividends (and using them to invest in something else instead) can help improve a portfolio's diversification over time. Even if you don't have an overly large position in a stock, you may not want to purchase more of it if it's already trading at a significant premium.
Most DRIPs allow investors to buy shares commission-free or for a nominal fee, and at a significant discount to the current share price; they may set dollar minimums.
Additionally, the dividends paid into DRIPs are taxed as ordinary dividends and must be reported in your tax returns, even though they are used to purchase shares. You can set up a DRIP for your entire account as well as for individual securities. Once you set up a DRIP, the cash dividend is automatically reinvested.
As long as a company continues to thrive and your portfolio is well balanced, reinvesting dividends will benefit you more than taking the cash will. But when a company is struggling or when your portfolio becomes unbalanced, taking the cash and investing the money elsewhere may make more sense.
It May Take Longer To Achieve Long-Term Financial Goals: Dividend reinvestment leads to compounded growth. This makes it easier (and faster) to achieve your long-term financial goals versus keeping cash in a savings account.
Capital Gains Tax for People Over 65. For individuals over 65, capital gains tax applies at 0% for long-term gains on assets held over a year and 15% for short-term gains under a year. Despite age, the IRS determines tax based on asset sale profits, with no special breaks for those 65 and older.
One of the key benefits of dividend reinvestment is that your investment can grow faster than if you pocket your dividends and rely solely on capital gains to generate wealth. It's also inexpensive, easy, and flexible.
A dividend is a reward to shareholders, which can come in the form of a cash payment that is paid via a check or a direct deposit to investors. DRIPs allow investors the choice to reinvest the cash dividend and buy shares of the company's stock.
A dividend reinvestment plan, or DRIP, automatically uses the proceeds generated from dividend stocks to purchase more shares of the company. This strategy allows investors to compound their returns over time by accumulating more shares, which themselves pay dividends that will be reinvested.
A Dividend Reinvestment Plan (DRIP) is a vehicle that lets shareholders reinvest dividends, in order to purchase full or partial shares of stock. Some of the most well-known publicly-traded companies offer DRIP programs, letting investors funnel as little as $10 back into their investments.
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