Long-term investors are the group most likely to benefit from using “DRIPs,” or dividend reinvestment plans. 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 grows every quarter with your DRIP stock, 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.
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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.
For investors that predominantly buy shares through their brokerage account, reinvesting dividends is an option offered via your broker directly.
This is a slightly different process for investors who enroll in a dividend reinvestment plan through a firm’s transfer agent. That type of investment is generally referred to as a Direct Stock Purchase Plan (DSPP), and it can have some benefits.
Namely, you can avoid transaction fees, and some DSPPs even allow you to buy shares at a discount, although it depends on the stock.
One popular use of DRIPs is buying shares as a gift to help kids and young investors get started. Because that’s generally an investment for long into the future (like saving for college), regular reinvestment and the potential of a discount can have a more meaningful impact.
Plus, the primary downside of a DSPP (that it takes more effort to sell shares compared to simply entering an order via your broker’s trading platform) is muted because you’re unlikely to be trading into or out of positions on a regular basis.
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.
What Are the Risks of Dividend Reinvestment Plans?
Investing in a dividend reinvestment plan is a great way to build wealth over time that many people do not take advantage of.
The risks of using a DSPP or dividend reinvestment are really no different from buying shares, with the primary risk being that the company you’ve invested in cuts its dividend or the share price declines.
Targeting stocks that have long histories of dividend payment (and thus prioritize rewarding shareholders) can help reduce that risk.
But that shareholder alignment only goes so far. If business conditions deteriorate, even long-term dividend payers (like Dividend Aristocrats) can cut dividends when there are no better options.
If you’re investing via a DSPP, you should be aware that transactions through a purchase plan can be a little more difficult than a trade placed through your broker, but if the DSPP offers a discount, that can more than make up for it.
Read The Pros and Cons of DRIP Plans for a deeper look at the risks and benefits.
What Are the Benefits of Investing in Dividend Reinvestment Plans?
Dividend reinvestment plans offer a number of benefits.
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 subject to commission fees, and shares are sometimes 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.
These benefits are dependent on the company offering the DSPP, and the best place to get started is with a company’s investor relations. That’s where you’ll find information about the transfer agent and the purchase plan offerings.
Is a Dividend Reinvestment Plan Worth It?
DRIPs are most valuable to long-term investors, especially investors who are most interested in building a position in a single company over time.
So, it does require that you have long-term faith in the underlying company. Dividend reinvestment plans aren’t appropriate for short-term positions or for your entire portfolio, but they can be useful as supplemental positions.
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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