Editorial Note: Forbes Advisor may earn a commission on sales made from partner links on this page, but that doesnt affect our editors opinions or evaluations.
A dividend reinvestment plan (DRIP) lets you buy shares of stock in a company with the dividend payments from that same company. Investors who opt into a DRIP take advantage of dollar-cost averaging, compounding returns and potential discounts on stock purchases to help maximize the value of their dividend investing strategy.
What Is DRIP Investing?
Dividend investing is a popular strategy for generating income and saving for retirement. When you buy dividend stocks, the companies you own pay you a portion of their earnings as dividends, based on the number of shares you own. Dividends provide cash flow from your stock investments without requiring you to sell any shares.
Investors can save their dividends, invest them or spend them as regular income. A dividend reinvestment plan automatically purchases more shares of a companyâ€™s stock with the dividends they pay out, whether thatâ€™s each month, quarter or year.
Not all public companies that pay dividends offer a DRIP. If a company you invest with doesnâ€™t offer a DRIP, your brokerage may enable you to automatically reinvest dividends.
Advantages of DRIP Investing
DRIPs help you take advantage of dollar-cost averaging. With a dividend reinvestment plan, you buy shares of stock at regular intervals, which may lower the average price you pay per share over time. In addition, you may be eligible to pay less per share through some DRIP plans that discount the current market share price for investors who reinvest their dividends.
Dividend reinvestment plans are also an excellent way to generate more compound returns. Investment returns compound over time, and reinvested dividends provide you even more compound growth. According to an analysis from Hartford Funds, 78% of S&P 500 returns going back to 1978 can be attributed to dividend reinvestment and their resulting compound returns.
Hereâ€™s how that plays out: Letâ€™s say you invested $10,000 in PepsiCo (PEP) in October 2010 and reinvested all dividend payments for a decade. Your initial investment would have bought 153.82 shares of PepsiCo. After a decade of dividend reinvestment, you would own 206.54 shares worth more than $28,800. Thatâ€™s an increase in over 50 shares and almost $19,000 without using any more of your money to buy new shares.
In the past, DRIPs offered a couple of other advantages that have become less relevant over time. DRIPs often charged zero commissions at a time when commissions ran high for stock purchases. They also gave investors access to fractional shares, which get dollar amounts too small to buy full shares into the market. Today, many brokerages charge zero commissions on stock trading and offer fractional shares of many leading stocks, diminishing these DRIP advantages.
How to Start DRIP Investing
There are a number of places to find DRIP stocks for your portfolio. You might start with the dividend aristocrats, a list of companies that have a long history of raising their dividends every year. To be considered a dividend aristocrat, a company must have increased its payout annually for 25 consecutive years.
Not all stocks can be aristocrats, but there are plenty of companies that pay regular, reliable dividends. As you research companies, look at their dividend histories to determine whether theyâ€™ve been paying consistently over timeâ€”even if they havenâ€™t increased the payout.
Once youâ€™ve determined which companies you want to invest in, you have a few options for DRIPs:
- Company-Operated DRIPs. A few large-cap companies that pay dividends operate their own DRIPs. Dow Jones Industrial Average (DJIA) members Coca-Cola (KO) and Johnson & Johnson (JNJ) manage their own direct stock purchase plans, which let you buy stock directly from them instead of a brokerage, as well as DRIPs, which reinvest the dividends earned on the stocks you buy through them.
- Third-party DRIPs. Most dividend-paying companies outsource the management of their direct stock purchase plans and DRIPs to third-parties, referred to as transfer agents. Computershare is one of the leading transfer agents, and its search portal is a great place to research and sign up for DRIPs. Keep in mind with company-operated and third-party DRIPs that you may have to pay fees to start investing or to buy subsequent shares; you can generally find brokerages that lack these fees. Brokerages will also allow you to invest in (and use DRIPs for) more than one companyâ€™s stock and even mutual funds and exchange-traded funds (ETFs), all of which are helpful for diversification.
- Brokerage DRIPs. Many brokerages facilitate DRIP investing. Simply choose your dividend stocks or funds, opt into your brokerageâ€™s DRIP and then, when you receive a payout in your brokerage account, your brokerage will automatically reinvest in new shares. Using DRIP plans at your brokerage or robo-advisor is probably the easiest way for most people to reinvest dividends.
- DIY DRIPs. If you would like to invest in a dividend company that doesnâ€™t offer a DRIP and no third parties or brokerage can facilitate dividend reinvestment for you, you can manage dividend reinvestment yourself. Simply purchase shares and fractional shares that reflect the dollar value of your dividend payment. If no fractional shares are available, hold onto the money until you have enough to buy whole shares. This DRIP process is more labor intensive, but you can still benefit from compound returns and dollar-cost averaging.
DRIP Investing and Taxes
A dividend is considered taxable income, and even if you directly reinvest your dividends without seeing them in your account first, theyâ€™re still reported to the IRS as income.
Dividend income is listed on Form 1099-DIV as either non-qualified or qualified. You should receive this form from your brokerage or direct stock purchase provider. Non-qualified dividends are taxed at your ordinary income rate while qualified dividends, which most dividends from U.S.-based stocks and funds are, get favorable tax treatment similar to long-term capital gains taxes.
Itâ€™s important to note that dividends from real estate investment trusts (REITs), employee stock options or master limited partnerships (MLPs) are not qualified dividends.
Should You Set Up DRIP Investing?
For beginners hoping to grow their portfolios faster through compounding returns, DRIP investing can make a ton of sense. It essentially provides you with free shares that then entitle you to more dividends that you can use to buy even more shares. Then youâ€™re even better posed to benefit from any increases in stock price. Remember: A large percentage of the S&P 500â€™s long-term returns have been from reinvested dividends.
However, if youâ€™re already past the growth phase of your portfolio and youâ€™re planning to live off your dividend income, it might make sense to stop with the DRIPs and start using the income they generate for everyday expenses.
Consider speaking with a financial or investment professional about your situation and goals to put together a portfolio strategy that works for you.
Find us at the office
Darmofal- Broderick street no. 11, 88736 Vatican City, Vatican City
Give us a ring
+90 293 316 242
Mon - Fri, 8:00-14:00