Investors looking to build long-lasting wealth are usually the first to ask, “What is a Dividend Reinvestment Plan?” Offered by some dividend stocks, a dividend reinvestment plan allows you to have your quarterly dividend payments allocated toward buying more shares (or fractions of shares) of that stock instead of being paid directly to you in the form of a check.
Thus, the amount of shares you own in a given stock automatically expands every quarter when you enroll in a DRIP, so long as that company keeps paying a dividend. This allows wealth to continue to accumulate as time passes and more shares are automatically purchased.
What Is a Dividend Reinvestment Plan and How Does It Work?
If you are a trader, you should know that DRIPs are tailored towards long-term investors, not traders, as they are meant to be kept for a period of multiple years. One group that benefits well from DRIPs is kids.
If a kid (and his/her parents) starts investing in a DRIP early in their lives and continues to do so, money will continually accumulate in that DRIP, providing the kid with a valuable sum of money they will be able to use once they turn 18.
However, DRIPs aren’t just for kids, they are available to everyone. In fact, DRIPs are a good strategy for people who may have investments in other stocks or who are just looking for another way to accumulate wealth.
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What Are the Risks of Dividend Reinvestment Plans?
Investing in a dividend reinvestment plan is a great way to generate income that many people do not take advantage of.
However, when investing, make sure to evaluate the company you are investing in to ensure that it aligns with your overall investment objectives and your temperament.
You don’t want to become committed to a dividend reinvestment plan with a company that is not projected to experience substantial growth over time.
The best companies with DRIPs that perform well are the ones that are already established and known but are still predicted to experience long-term success. Also, avoid companies that have proven to be highly volatile in the past.
Since DRIPs are long-term investments, you should steer clear of companies that could experience frequent and sharp downtrends and target the companies with stable growth prospects.
While whatever company you invest in is obviously going to experience some downtrends, you do not want to be invested in a company whose frequent downtrends could hinder potential growth.
Read The Pros and Cons of DRIP Plans for a true list of risks and benefits.
What Are the Benefits of Investing in Dividend Reinvestment Plans?
Dividend reinvestment plans are accompanied by many benefits that regularly traded stocks do not possess.
First, most DRIPs are very affordable and initial minimum investments do not usually exceed a couple hundred dollars (most are usually well below that mark). In addition, many initial investments in DRIPs can be purchased directly from the companies offering them, bypassing the need to deal with a broker (unless the company does not offer a Direct Stock Purchase Plan).
Second, you should know that most DRIPs are not accompanied by commission fees and shares are usually offered at discounted rates, commonly ranging from 1%-10% lower than the regular share price. This makes initial and future investments in a DRIP relatively cheap.
Third, since DRIPs are long-term investments and returns automatically reinvest themselves, there is less need for investors to micromanage their accounts.
Fourth, DRIP investors who are in it for the long term tend to not stress over market declines as they acknowledge that their investments will play out well over the life of their entire investment.
What Is a Dividend Reinvestment Plan Worth to Your Portfolio?
Ultimately, dividend reinvestment plans can foster excellent opportunities for you to diversify your portfolio and expand your income. For the long-term investor, and everyone interested in accumulating more wealth, DRIPs are a great strategy to generate impressive returns.
Why DRIPs Are Worth It:
- Benefit 1: Increase your position with no fees
- Benefit 2: Automatically invest, without having to think about it
- Benefit 3: The power of compounding adds up fast.
Why DRIPs Are Not Worth It:
- Drawback 1: You may need the dividend income
- Drawback 2: You may need to reallocate your positions
- Drawback 3: You may not want to buy that stock at that time.
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