DRIP: How Does It Work?

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One of the best ways to grow your wealth in the stock market is buying quality stocks and holding onto them for a long time. And one smart way to achieve the full advantage of the power of long-term investing is by reinvesting your dividends through a dividend reinvestment plan.

What is a Dividend Reinvestment Plan?

A dividend reinvestment plan, or DRIP, is a way for you, as an investor, to use your cash dividends to purchase additional shares or fractional shares of the stocks in your portfolio. It can be set up through a lot of individual corporations, but the easiest way to put all of your stocks in a DRIP is through your brokerage. This way, you don’t need to worry about it when you buy new stocks, and it is where the benefits of dividend reinvestment will automatically start.

See also Exactly How Would You Know if Your Stocks are Hopeless

How Does it Work?

In most scenarios, investors, who are more optimistic, choose to get additional equity in a company rather than obtain the cash dividends related to their holdings. A dividend reinvestment plan gives investors a system of repetitive dividend reinvestments. In other words, rather than taking cash from a declared dividend, participating investors gain shares and fractional shares of company stocks of equivalent value.

For instance, the stock of company ABC is valued at $10 per share. ABC reports a dividend of one dollar per share. A DRIP investor holding 100 shares will gain 10 shares of company stock. In other cases, these shares are discounted and have no brokerage charges.

Dividend Reinvestment Plan

Why Use DRIP?

Here are some interesting reasons why you should use a DRIP instead:

NO COMMISSIONS

You would not be charged a brokerage commission when your dividends are used to purchase more shares through a DRIP. Although the brokerage commission nowadays that worth $10 may not seem like much, you may consider that if you have 10 stocks that pay quarterly dividends, this benefit alone could be translated into $400 per year.

NO REQUIRED MINIMUM INVESTMENT

Mutual funds let you reinvest dividends, but commonly have minimum investment requirements. With individual stocks, you can put in a DRIP if you own only one share.

ABILITY TO BUY FRACTIONAL SHARES

Suppose you gain a $100 dividend payment from a stock that trades for $60 per share. If you buy shares on the open market, you can only afford to buy one. But with a DRIP, you can buy 1.67 shares. In short, a DRIP helps you to put your whole dividend to work right away.

DOLLAR-COST AVERAGING

Your dividends purchase more shares when your stocks are cheaper, and they buy fewer shares when your stocks are expensive. With dollar-cost averaging, there is a mathematical certainty that eventually, you will end up with a better-than-average cost per share.

AUTOMATIC INVESTING

DRIP is known as a low-maintenance form of investing. As you are able to only buy an initial amount of shares and your brokerage will automatically make future purchases on your behalf, a DRIP attracts the most effective kind of investing and savings – buy and hold for a long period of time.

See also Pros and Cons of Dividend Reinvestment Plan Investing

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