Do you want to reinvest your dividends without thinking about it? Then you may need drip investing. Learn all about how to automatically reinvest your dividends with a DRIP plan.
DRIP stands for Dividend Reinvestment Plan. This is an arrangement whereby dividends are automatically reinvested in more shares. Thus, the DRIP makes it easier, and sometimes cheaper, to reinvest dividends.
Before joining a DRIP plan, it is helpful to understand how it works, what its advantages and disadvantages are, and how you can join.
What is DRIP Stock Investing?
When you buy dividend stocks, companies periodically pay you to own their stock. Dividends are a way for a company to thank you for investing in us, and dividends mainly come from the company’s profits from the previous year.
In the DRIP, instead of receiving this small dividend check at the end of each fiscal period, the company reinvests the dividend payment and buys more shares in the DRIP.
A DRIP plan can help maximize the value of your shares as you take advantage of compound earnings, possible discounts, and dollar value averaging. But in order to benefit, you will need to sign up for a DRIP plan.
How does DRIP Stock Investing work?
Dividends are shareholders’ returns on their investments. This is usually cash, which can be paid by check or credited directly to the shareholder’s account.
The DRIP offers investors the opportunity to reinvest their cash dividends and purchase shares in the company. However, they will need to buy shares directly from the company. Since the shares come from the company’s reserve, they are not listed on the exchange.
For example, you have 1,000 shares of a company that pays $ 1 per share in dividends. Hence, if you sign up for the DRIP program, you will receive $ 1,000 in dividends. However, if we assume that the company’s shares are trading at $ 50 at the time the dividend is received, you will be allocated an additional 20 shares instead of a dividend check.
Fractional shares
The dividend payout is not limited to a whole share, and therefore these plans are unique. Companies keep good records of their shareholdings. As the words suggest, fractional stocks are part of a whole stock. This means you can own 1.75 shares instead of two.
Now, suppose the stock of the company in our example above was selling at $ 45. This means that your $ 1,000 dividend payout will allow you to purchase 22.22 shares under the DRIP plan. However, not all brokerage platforms have fractional shares. Therefore, if there is money left after buying the full shares, it is usually credited to the investor’s account.
Pros of DRIP Stock Investing
Here are the benefits of dividend reinvestment plans.
- Averaging the dollar value. When you reinvest your dividend, you are essentially averaging dollar spending. Dollar value averaging is the repeated purchase of an investment instead of a one-time lump sum investment. When you regularly buy additional stocks, you can spread your purchases and get the average purchase price regardless of market conditions.
- Immediate reinvestment. Since dividends are automatically reinvested to buy more shares, DRIP can minimize the chances of your money running out of business since you don’t have to do it manually. On the other hand, if you keep forgetting to reinvest your money, your investment may not pay off over time.
- Lower fees. If you join the DRIP program through a brokerage firm, it may not charge a fee on reinvested dividends. However, this depends on the broker.
Cons of DRIP Stock Investing
Here are the disadvantages of drip investing:
- Taxation. Dividends are considered taxable income. Even if you reinvest your dividends before they go into your bank account, they will still be shown as income on the IRS. When you enroll in the DRIP program, you should remember that you may be required to pay up to 20% in taxes on reinvested dividends. You will need this amount in cash. Otherwise, you may have to sell some of your shares to get the money.
- Non-diversification. After you set up a DRIP plan for a single stock, you can accumulate a significant portion of that stock over time. As a result, it prevents you from diversifying and may put you at greater risk. Consequently, you may need to keep checking your portfolio and rebalancing if necessary.
How to start investing in DRIP stocks?
If you want to benefit from DRIP investing, you need to have at least one share of the company in your name. You can then contact the broker to see if they have a DRIP investment program. The transfer agent usually handles the DRIP account, but it can also direct you to the correct agent.
Some brokerage firms also allow shareholders to reinvest their dividends for free through their plans. If you have already bought stock through a broker, you may want to consider this option. When you log into your online account, select the dividend reinvestment option. If you have a consultant, you can call them to walk you through the process.
Some brokerage firms, such as M1 Finance, do not offer traditional DRIP. However, they do suggest reinvesting the dividends you received into your entire portfolio, which will also help to increase the impact of your portfolio over time.
Company operated drippers
Some companies with significant market capitalization use DRIP. Examples are Johnson & Johnson and Coca-Cola, which manage their outright buying plans, allowing investors to buy shares directly from them rather than through stock brokers. They also have DRIP plans allowing investors to reinvest the dividends they earn from stocks.
Brokerage DRIP
There are many brokerage companies that facilitate DRIP investing, such as Vanguard or TD-Ameritrade. All you have to do is select dividend stocks and participate in your DRIP brokerage. You will then receive a payout in your brokerage account as the form will automatically reinvest in new shares.
Using DRIP plans with a broker is usually the easiest way to reinvest dividends. One of the benefits of using brokerage firms is that they can offer you the opportunity to invest in DRIP with more than one company, which can help diversify.
Third party DRIP
Most dividend paying companies outsource DRIP programs and direct share purchase plans to third parties, also known as transfer agents. Computershare is a popular transfer agent. You can visit their search portal to subscribe to DRIP. Please be aware that you may be charged for third party or company DRIP programs.
DIY DRINKS
If the company you would like to invest in does not have a DRIP plan, brokerage services, or third parties to facilitate reinvestment, you can reinvest the dividend yourself. All you have to do is buy stocks or fractional stocks that reflect the dollar value of the dividend paid to you. Although it is not that easy, it is an option.
If fractional shares are not available, you can hold the money until you have enough shares to buy an entire share.
One of the disadvantages of this method is that it takes longer than traditional DRIP. However, it can still work and you will benefit from the cumulative return as well as the dollar cost averaging.
Want to know more fun facts about investing? Find out what time the stock markets open for trading.
Best No Commission DRIP Promotions
There are several places where you will find DRIP stocks to add to your portfolio. First, you can check out Dividend Aristocrats, companies that have been increasing their dividends annually for at least 25 years.
The combination of DRIPS and dividend aristocrats can be powerful. Focus on companies that have increased their dividends over the past 25 years. They will probably make a great addition to your dividend portfolio, which will bring you more stocks each year.
Here are ten of the top aristocrats receiving dividends without commission:
- AbbVie Inc.
- Johnson and Johnson
- Exxon Mobil
- S&P Global Inc.
- 3M company
- Real estate income
- Aflac Incorporated
- Federal real estate investment fund
- Chubb Limited
- Hormel foods
Some companies also run share buy programs for their employees. Instead of paying dividends by check, they offer their employees the opportunity to reinvest their money back into the company’s stock. This program became so popular that it was extended to shareholders. These companies include:
- 3 million
- PepsiCo Inc
- Exxon Mobil
Therefore, these companies are excellent choices for DRIP programs. As you study companies, check their dividend history to determine how consistently they paid, even if they did not increase their dividend every year.
In conclusion – DRIP Stock Investing
If you want to grow your portfolio faster by increasing profits, DRIP investing is a great option to invest wisely. Drip investing means that you reinvest the dividends paid to you by companies so that they own more shares. Next year, you will increase your dividend payout and own even more shares in the company.
Compounding will start slowly and over time you will find that you will have more and more shares. Then, if you count the rise in stock prices as well, your ROI will increase.
To learn more about drip investing, you should consider talking to an investment or financial advisor about your goals and situation. They can help you create a portfolio plan that works for you and your investment goal.