Dividend Reinvestment Plan (DRIP) | Types, Benefits, & Drawbacks (2024)

Dividend Reinvestment Plan (DRIP) Explained

A dividend reinvestment plan is an investment program that allows shareholders to reinvest their cash dividends in new or fractional stock shares.

Although the word can refer to any automatic reinvestment plan set up through a brokerage or investment institution, it often refers to a publicly listed organization's formal program given to current shareholders.

Dividend reinvestment arrangements are usually commission-free and give a discount on the current share price.

How It Works

DRIPs are administered by the company whose stock is being purchased. When an investor enrolls in a DRIP, the company uses the cash dividends that would ordinarily be paid out to reinvest back into more shares of the company's stock.

On the other hand, investors can acquire shares directly from the specific firm via direct stock purchase schemes (DSPs).

These additional shares are then typically issued to the investor at a discount to the current market price.

Types of DRIP

There are three main types of DRIPs: company-operated, third-party-operated, and broker-operated.

Company-operated DRIP

Businesses run their DRIP, with a dedicated department in charge of the entire strategy.

In this type of plan, the company uses cash dividends to purchase more shares on behalf of the investor. The number of additional shares an investor receives is based on the dividend payment and the share price at the time of reinvestment.

Third party-operated DRIP

With this type of DRIP, a third party (often a bank) manages the plan on behalf of the company. This is typically the option when a company's own DRIP is too costly or time-consuming to operate.

As with company-operated plans, the investor's cash dividends are used to reinvest additional shares.

Broker-operated DRIP

Broker-operated DRIPs are set up and managed by investment brokers. In most cases, the broker will hold the securities in an account on behalf of the investor.

Brokers acquire shares on the open market using a broker-operated DRIP. Depending on customer relationships, they often charge little to no commission for DRIP stock purchases.

Setting Up A DRIP

Before signing up for a DRIP, investors should research the company to ensure it is a good long-term investment.

Investors should also be aware of their broker's fees, if any, and the minimum investment requirements.

The type of DRIP you choose determines the set-up process.

Company-operated DRIPs

DRIPs run by companies are generally available through the company's investor relations page. Even if a corporation doesn't enable you to buy stock directly from them, current shareholders may be able to acquire stock with dividends reinvested.

Third Party-operated DRIPs

To enroll in this type of DRIP, shareholders need to open an account with the financial institution administering the plan on behalf of the company by filling out a form for the dividend-yielding stock they choose.

Some firms also offer partial DRIPs, which enable you to reinvest a portion of your dividends and cash out the rest.

Broker-operated DRIPs

Investors can typically sign up for a broker-operated DRIP through their online broker. If an investor doesn't have a broker, they can open an account with a brokerage firm that offers DRIPs.

Benefits of a Dividend Reinvestment Plan (DRIP)

Enrolling in a DRIP has various advantages, including the following:

Commission-free stock purchases: One of the biggest advantages of DRIPs is that they are normally commission-free. This means that investors can reinvest their dividends without incurring any additional costs.
Automatic reinvestment: DRIPs offer a hands-off way to reinvest dividends and grow your investment over time. Since the reinvestment is automatic, you don't have to worry about manually reinvesting your dividends.
Discounted stock prices: Many companies offer a discount on the share price when you enroll in their DRIP. This can be a percentage of the market price or a fixed dollar amount.
Compounding interests: Reinvesting your dividends can help accelerate the growth of your investment portfolio through the power of compounding.
Alternative to online investing: For investors who don't want to trade stocks online, DRIPs offer a way to grow your investment without buying and selling shares.
Capital for companies: DRIPs can also be beneficial for companies. By reinvesting dividends, shareholders can provide additional capital that the company can use to finance operations or expand its business.

Drawbacks of Dividend Reinvestment Plan (DRIP)

There are certain drawbacks to consider before participating in a DRIP, including the following:

Minimum investments: Most DRIPs have a minimum investment requirement. This may be too costly for some investors, especially if you are starting.
Fees: While many DRIPs don't charge commissions, some have associated costs. These fees can include enrollment, account maintenance, and transaction fees.
Limited investment options: DRIPs usually only offer one investment option: the company's stock that operates the plan. This can limit your investment choices and prevent you from diversifying your portfolio.
Unbalanced portfolio: Since DRIPs typically only offer one investment option, your portfolio can become unbalanced if you reinvest all of your dividends. This can be a risky strategy, especially if the company's stock price falls.

Key Takeaways

A DRIP is a dividend reinvestment plan that enables shareholders to reinvest their dividends to buy additional shares of stock. This strategy is often used to grow an investment over time.

DRIPs offer several advantages, including commission-free stock purchases, automatic reinvestment, and discounted stock prices.

There are also some drawbacks to consider before enrolling in a DRIP, such as minimum investment requirements, fees, and limited investment options.

When you want to enroll in a DRIP, you should weigh the pros and cons to see if it is the right investment strategy for you.

FAQs

1. What is a DRIP?

A DRIP is a dividend reinvestment plan that enables shareholders to reinvest their dividends to buy additional shares of stock.

2. How do DRIPs work?

When you enroll in a DRIP, your dividends will be automatically reinvested to purchase additional shares of stock depending on the type of DRIP you choose.

3. What are the different types of DRIP?

There are three main types of DRIP: company-operated DRIP, third-party-operated DRIP, and broker-operated DRIP.

4. What are the benefits of DRIP?

Some of the benefits of DRIP include commission-free stock purchases, automatic reinvestment, and discounted stock prices.

5. What are the drawbacks of DRIP?

Some of the drawbacks of DRIP include minimum investment requirements, fees, and limited investment options.

Dividend Reinvestment Plan (DRIP) | Types, Benefits, & Drawbacks (2024)

FAQs

What are the disadvantages of a dividend reinvestment plan? ›

DRIP plans could throw your portfolio off balance. If you reinvest through a DRIP continually, you may accumulate a larger position in the company than intended. Overexposure to a particular company could increase your risk and hurt you in the long run if your portfolio doesn't have a good mix of assets.

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Should I use drip to reinvest dividends? ›

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.

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Why would you not want to reinvest dividends? ›

If you reinvest dividends, you'll be making small purchases every quarter, potentially leading to many separate tax lots with different cost-basis levels. That can complicate matters when you eventually sell the stock, since you'll need to match up each sale with a specific tax lot.

Is a dividend reinvestment plan worth it? ›

Dividend reinvestment can be a good strategy because it is: Cheap: You won't owe any commissions or other brokerage fees when you buy more shares. Easy: When you set it up, dividend reinvestment is automatic. Flexible: Though many brokers won't let you buy fractional shares, you can with dividend reinvestments.

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Does drip avoid taxes? ›

Although Schwab doesn't charge fees or commissions in DRIP, there is still a tax scenario to consider. If a DRIP is active in a non-retirement account, the dividend income is a taxable event and will be reported on your 1099-DIV as if it was received in cash.

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Are DRPs a good idea? ›

A DRP is a great tool to help investors achieve a range of investment outcomes, including: earning compounding returns.

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How do I avoid paying taxes on reinvested dividends? ›

To do this, simply hold the dividend-paying securities in a tax-deferred retirement account such as a 401(k) or IRA. Contributions to these accounts may be tax-deductible, so your dividend reinvestments escape taxation at the time you make them. After that, your money grows tax-free over time.

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Do I pay taxes on dividends I drip? ›

Even though investors do not receive a cash dividend from DRIPs, they are nevertheless subject to taxes, due to the fact that there was an actual cash dividend--albeit one that was reinvested. Consequently, it's considered to be income and is therefore taxable.

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Do I pay tax on dividend reinvestment? ›

Dividend reinvestment plans

Crucially, if you reinvest a dividend in this way, your income tax liability on the dividend is calculated in exactly the same way as if you'd received a cash dividend. That means you may have an income tax liability – and no cash to settle it with because the cash was all reinvested.

Should retirees reinvest dividends? ›

Dividend reinvestment can be a lucrative option for retirees as long as they have other sources of short-term income. In fact, dividend reinvestment is one of the easiest ways to grow your portfolio, even after your earning years are behind you.

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Is drip worth it? ›

Benefits to Investors

Company-operated DRIPS are popular with shareholders as a lower-cost option to accumulate additional shares. There are often no commissions or brokerage fees involved. Many companies offer shares at a discount through their DRIP ranging from 3 to 5% off the current share price.

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Which is better growth or dividend reinvestment? ›

Which option is better – growth or dividend reinvestment? The gross value of your holding in both options is usually comparable. However, growth options score in the aspect of tax efficiency, making the net value more than dividend reinvestment options in most cases.

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What is the average market return with dividends reinvested? ›

As of mid-2024, the average return on stocks in the last 30 years, with dividends reinvested, is 10.52%. The average return with dividends reinvested and inflation-adjusted over the previous 30 years is 7.78%.

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Is there a downside to dividend investing? ›

Despite their storied histories, they cut their dividends. 9 In other words, dividends are not guaranteed and are subject to macroeconomic and company-specific risks. Another downside to dividend-paying stocks is that companies that pay dividends are not usually high-growth leaders.

Can you opt out of dividend reinvestment plan? ›

Yes. You can terminate or vary your participation in the DRP at any time by submitting a new Election. The Election must be received by ANZ's Share Registrar by 5pm (Melbourne, Australia time) on the next relevant DRP Election Date to be effective for that dividend.

Which is better dividend reinvestment or growth? ›

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Do you have to pay tax on dividend reinvestment plans? ›

What is a downside of dividends and capital gains being reinvested in a mutual fund? ›

When capital gains or income distributions are reinvested into a mutual fund shareholder's account, the payout increases the cost basis on that account. This is because the distribution is part of the shareholder's tax information for the year it is paid.

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