What is a DRIP for Stocks?

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When companies pay dividends to their investors, the receiver decides what is done with the cash. Some choose to reinvest their dividends, but some choose to have the cash paid out. Many investors use a Dividend Reinvestment Plan (DRIP) to invest the cash dividends they receive back into more stock from that company.

How Does DRIP Investing Work?

A dividend is a distribution of profits by a corporation paid to shareholders. It is usually paid when a company earns a profit or surplus to keep shareholders satisfied. It incentivizes investors to hold or invest further funds into the stock.

DRIPs give investors the opportunity to reinvest their dividends to purchase more shares of the company’s stock. These plans can be set up directly with the company or through a brokerage account. Investors can compound their gains with the dividend reinvestment program and reduce risk via dollar cost averaging (DCA).

For example, an investor owning 100 shares of a stock may choose to reinvest the dividends. The company pays a $0.10 quarter dividend per share, and its stock price is currently at $10. Therefore, owning 100 shares will mean the investor receives a dividend of $10.

A DRIP will use that $10 to buy more stock. As a result, the investor receives one extra share, increasing the position and dividend on the next payment.

DRIPs have been a popular investment strategy as investors can accumulate additional shares at a consistent rate while averaging the price of entry.

According to CFRA Research, reinvested dividends have contributed to 33% of the total return in the S&P 500 since 1945. As a result, dividends can improve your performance without you having to log in and invest more of your money.

You set up a DRIP through a broker or transfer agent, usually online. Once selected, a feature in your account offers various options on how to use a dividend reinvestment plan.

Investors can automatically enroll all current and future stocks and funds for an automated DRIP investing experience as any stock or fund that enters your portfolio can be automatically added to the program. When a company in your portfolio chooses to pay a dividend, it will automatically be reinvested.

Another option is to enroll all the current stocks and funds in a portfolio. However, this process will only reinvest the dividends from your portfolio at that time. Any new stocks added to the portfolio over time must be added manually. Investors must consider whether they want the convenience of dividend reinvestment automation or to retain some control over their dividends.

Investors can also take complete control of their dividends and select individual stocks and funds to automate. This dividend reinvestment process will be less convenient but allows the investor to take more initiative and have the final say.

Finally, individuals can go directly to the company to buy its stock and reinvest its dividends. This plan has additional benefits and drawbacks.

Can You Set up a DRIP for Fractional Shares?

Investors are able to use a dividend reinvestment for fractional shares. A DRIP is not limited to whole shares, which gives investors more opportunity to use this purchase plan for various stocks.

DRIP investing for fractional shares occurs when the dividend payment is less than the total share cost. Therefore, the investor will receive fractional shares as a result.

For example, if the company’s share price is $50 and the investor receives a dividend of $10, it will be reinvested as fractional shares through the dividend reinvestment program. The investor will receive one-fifth of a share from its dividends. Thus, investing through the DRIP plan is available to all, whether it is a large investment or a small investment.

Using a DRIP for fractional shares is common for more expensive stocks. For example, a stock such as Apple has a high share price and would require a significant investment to cover one whole share. Owning 20 shares of Apple will translate to a small dividend payment that can only be reinvested into fractional shares.

The Benefits of a DRIP

An investment plan such as a DRIP is popular and is used by many investors and corporations. Reinvesting your dividends can significantly increase profits over the long term. In fact, there are income investors that tailor their entire stock purchase plan around just stock dividends and increasing their cash flow. But what are some of the significant benefits you can achieve?

Easy Setup 

Setting up a dividend reinvestment plan can be straightforward, and once completed, it is an automatic system. It can be done either through your broker or with the company itself. There is minimal hassle, and once it is set up, it can be left alone.

Dollar-Cost Averaging 

The technique of dollar-cost averaging is beneficial. It intends to average an investor's position as the stock moves up and down. You are not entering at an outright price but rather getting in at different levels over the long term. As a result, it reduces risk as you are not buying during a peak or trough. Dividend stocks specifically can benefit from dollar-cost averaging.

Lower Cost

Many DRIP programs are popular because of the minimal costs involved. Often you will see no brokerage commissions or fees, ensuring investors can use its plan free of charge.

Meanwhile, using a DRIP through the company means investors may be offered their shares at a price discount ranging between 3% and 5%.

Steady Growth

Investing your dividends over a long period of time is a way to achieve steady growth. Investors buy more shares with each payment, which will compound their returns if the company continues to pay dividends.

Compounded returns can add up to a significant portion over time, which has been evident with many firms and indexes in the past. It is an excellent strategy to try to achieve steady growth over the long term, and the consumer can cancel it at any point. Reinvestment can do wonders for growth, but it is prudent to take into account your cost basis or original purchase price and your price target of your stock to maximize returns.

Safety

Companies offering DRIP programs see their dividends reinvested into the company. Consequently, companies can reinvest the capital to grow their business.

Shareholders are likely to remain loyal to the company and unlikely to sell during uncertain times. Over time the investment may be safer from significant drops in its common stock price. Investors are in it long-term, and each party can benefit from dividend reinvestment.

Saves Time

A DRIP is highly convenient and can save the investor a lot of time. The broker or company handles the rest of the management.

Considerations of a DRIP

The use of a DRIP can be beneficial, and investors can see higher returns over the long term. However, all investments carry some degree of risk. Additionally, companies that have dividend payouts can decide to stop paying them at any time.

Here are some key considerations of a DRIP.

Taxes

One thing to note is the cash dividends received and reinvested for dividend stocks are still considered taxable income by the IRS. As a result, it must be reported, and you may need to seek a tax professional to analyze your current situation.

Risk

Every investment comes with some degree of risk, and that risk increases as you buy more shares. A considerable drop in share price could occur. Therefore, if you are continuously reinvesting in a business, it must be in a corporation you feel confident in.

Costs

Although using a DRIP brings limited fees and expenses, reinvesting dividends is not an option for everyone. Many individuals need the money they receive from dividends to cover their everyday costs. Therefore, this option is only available to those who do not need the funds they receive.

Flexibility

If you work directly with the company to use DRIPs, one thing to consider is the flexibility of buying and selling the stock. You may be unable to buy and sell as quickly as possible through a regular brokerage account.

In a regular account, you can respond more quickly to a sudden rise or fall in the market. In contrast, you are likely to have less direct control when dealing with the corporation, as you must sell the shares back to the company.

You cannot sell the shares on the open market, and a request to sell them must be made with the firm.

Find Your Balance

A DRIP allows investors to reinvest their dividends and accumulate more shares of a company's stock. DRIPs offer benefits such as easy setup, dollar-cost averaging, lower costs, steady growth, safety and time-saving convenience. 

However, there are considerations such as tax implications, risks, costs and limitations on flexibility. Despite these considerations, DRIPs are a popular investment strategy for those seeking to enhance their portfolio's growth and take advantage of reinvested dividends.

Compare Brokers for DRIP Stock Investing

A DRIP is offered by numerous brokers and corporations directly. However, as multiple brokers are available, it can be challenging to choose the ideal one. Here are insights and reviews from Benzinga on some of the biggest brokers who offer DRIPs to investors.

Frequently Asked Questions