A DRIP, or Dividend Reinvestment Plan, is a program that automatically uses your cash dividends to buy more shares of the same stock, or fractional shares, without paying a commission. This allows investors to compound their returns over time by increasing their ownership in a company, potentially through share discounts offered by some plans. The term “drip plan” is often used interchangeably with DRIP, and sometimes refers to Distribution Reinvestment Plans, which work similarly for other types of investments like mutual funds.
How it works
- An investor receives a cash dividend from a stock.
- Instead of taking the cash, the investor’s account automatically uses the money to purchase more shares of that same stock.
- This can include buying fractional shares, so every dollar is put to work.
Benefits of a DRIP
- Compounding: Dividends from the new shares can also be reinvested, helping your investment grow exponentially over time.
- Dollar-cost averaging: By reinvesting regularly, you buy shares at an average price, which can help reduce risk over time.
- No commissions: Many DRIPs allow you to reinvest dividends without paying a brokerage commission.
- Potential discounts: Some company-offered DRIPs may allow you to purchase shares at a discount to the current market price.
Potential downsides
- Limited diversification: Since dividends are reinvested in the same security, DRIPs can lead to an over-concentrated portfolio.
- Taxes: You are still responsible for paying taxes on the dividends you receive, even though you don’t get the cash.
- Paperwork: Managing multiple company-specific DRIPs can lead to more paperwork than having a single brokerage account.
