What is a dividend reinvestment plan (DRIP)?

by Hank Coleman

I bought shares of individual stock without having to pay a commission. No one got in the way or received a $7 per trade cut in my stock purchase. I love buying stocks through dividend reinvestment plans, which are also called DRIPs (pronounced drips). A dividend reinvestment plan is basically an equity investment option offered directly from the company that is providing the shares of stock. The name of the investment comes from how the company’s dividends are reinvested into new shares of the company. This choice is gaining popularity nowadays because of its returns and low fees with no commissions.

The Advantages. There are many advantages to investing in a DRIP program. First of all, it is inexpensive. Very few companies require a commission to purchase shares. DRIPs are also easy to gain admission into the program. Most DRIPs are very easy to enroll in and most of the paperwork can normally be filled out under a minute. Most large Fortune 500 companies offer a DRIP plan, and many of them can be found online through a third party company that manages the program for the company such as ComputerShare.com or AmStock.com.  For example, Coca-Cola, Tim Horton’s, Caterpillar, Dell, Microsoft, Wal-Mart, and almost every large company in America participate in DRIP programs.

With a DRIP, investors do not usually receive their quarterly dividends in cash, but instead the dividends are directly reinvested in the company’s stock. This form of investment has a long term compounding effect for its investors. It could lead to price appreciation as well as compounding dividends without having to incur any brokerage fees or waiting to accumulate enough cash for a full share of stock. DRIP programs also save time for shareholders since it is completely automated. You will not have to pay too much attention or monitor your investments. Most reinvestment programs allow the investor to buy fractional shares with a set monthly investment thanks to dollar cost averaging that could result in more wealth in the investor’s hands over the long run. In this program the investors can buy additional shares for a nominal fee. Most DRIPS carry an option called the optional cash purchase with a very low minimum investment requirement. You could invest with as low as $10 and go up to a maximum budget of thousands.

The Disadvantages. One downside is that the investor will still have to pay income tax from his or her dividend income, whether it has been received or reinvested back into new shares of the company’s stock. At the end of the year, investors will receive a 1099-DIV form from the company listing the income earned that has to be included with your income tax return. Another disadvantage is that many companies require that the investor own a share of stock in their own name instead of in street name at a brokerage. This can cost a one time fee of $30-40, but it can be worthwhile and negligible over the long term.

Participating in this reinvestment plan helps you in adopting a long term horizon for your investments since it forces you to buy stock on a regular basis. Your money is automatically reinvested in this program and the automation does most of the work for you while stressing the benefit of long term investing. You can also find out about each company’s specific DRIP program on their websites in the investor relation section.

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{ 1 comment… read it below or add one }

TCS July 7, 2010 at 4:04 am

Hi, is such plan available outside of US? or can non-US resident enroll in such plan? Thanks!

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