Dividend Reinvestment: How To Plan Your Money Flow

Written by 
Tommy Syrmolotov
/
December 6, 2021

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Table of contents

A dividend reinvestment plan (DRIP) is a plan that lets shareholders reinvest their cash dividends in additional or fractional shares of their stock.

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This reinvestment program involves reinvesting the dividends received on the date of dividend payment. DRIP programs can be the automatic reinvestment options that most brokerage or investment companies offer, as well as a formal drip stocks plan provided by a company for its stocks and dividends.

What is DRIP in Investing?

When companies pay dividends, they are usually released to shareholders through check or cash deposit into their specified account. Dividend reinvestment plans, known as DRIPs, are a convenient means to reinvest dividends. Dividend reinvestment stocks give shareholders the chance to invest in more shares of a stock they already hold. DRIP stocks allow investors to opt for direct dividend reinvestment of shares that they already own. 

Shares bought through a DRIP investing strategy are purchased from the share issuer and come from the company's reserves. This means that shares bought this way cannot be traded like standard shares on the stock market.

Having a DRIP account lets you buy stocks for your portfolio without paying any commission or for a comparatively low fee. These would be priced significantly lower compared to the prevailing market rate. Drip stocks are usually issued with minimum investment and selling requirements. 

Most DRIPs are issued for people who have opted for the dividend reinvestment plan (DRIP) and already possess regular company shares. However, some companies offer DRIP investment for new investors subject to some minimum investment parameters.  

Three Common Types of DRIPs

There are three types of DRIPs, depending on who they're operate by: the company, a third party or a broker.

Company-Operated Dividend Reinvestment Plan

Some companies that are in the large-capitalization category run their DRIPs. For instance, S&P 500 Index members Abbott Laboratories (ABT), 3M Company (MMM), and Johnson & Johnson (JNJ) run their dividend reinvestment plans. 

These plans offer investors the benefit of no-fee options, which reduces your investment cost and makes the DRIP reinvestment process straightforward. 

Third-party Operated Dividend Reinvestment Plan

Many companies that offer options for DRIPs outsource the management of their DRIP program to third-party agents. These agents are known as transfer agents. You need to remember that these agents usually have some fees for opening an investment account and for buying and selling subsequent shares. Most of these agents will have websites and portals for searching and researching DRIP reinvestment stocks. 

Broker-Operated Dividend Reinvestment Plan

Most brokerage firms also offer guides and options on how to invest in DRIP stocks. Investors just need to pick the invest in DRIP options and start DRIP stock investing. You just choose the stocks for your portfolio, add them to your brokerage's DRIP. Your brokerage will begin to reinvest dividend payments into new shares in your DRIP portfolio. A DRIP method implemented through a brokerage or even a robo-advisor is the best investment strategy for DRIP reinvestment. 

4 Benefits of a Dividend Reinvestment Plan for an Investor 

Now that we know what is drip in investing, let's discuss is dividend reinvestment good in the short-term and the long term?

  1. Fees free reinvestment

As margins and portfolio returns shrink, drip investing, meaning low or no fees, is levied on the reinvestment of your capital in shares that are already in your portfolio. This means low-cost fund investing and helps to improve the weighted average cost of investment and improves aggregate portfolio returns. 

  1.  Grow shares with less capital

Dividend reinvestment meaning to the term low-cost reinvestment. It gives access to additional shares of companies at a discount compared to the current market price of the shares. This allows investors to grow their portfolios with a lower outlay of capital.  

drip cycle dividends photo
Figure 1. The DRIP Cycle
  1. DRIP into Portfolio Compounding 

In accounting terms, what does drip stand for in finance? Opting for a DRIP allows investors to enjoy portfolio compounding with little expense. As a company issues dividends, they continue to be reinvested into more shares through the DRIP plan. This reinvestment allows investors to increase their number of shares, which increases their dividends, and then the number of shares rises as dividends get reinvested into more shares. This allows for portfolio returns to be compounded. 

the power of dividends and compounding photo
Figure 2. Dividend Compounding
  1. Long term Portfolio Returns and Access to Capital

Investment in a DRIP stock means investing over a long-time horizon. This matches with the strategy of investing in dividend stocks and with the core of what are DRIPs. The company gains long-term stability with a shareholder locked in due to access to cheaper investment. The company gets market stability and access to a stable set of shareholders. 

How to Start Your Dividend Reinvestment Plan?

To start your dividend reinvestment plan you will have to look at different plans and pick the one you prefer. We have already answered the question “what is a dividend reinvestment plan?” and how it can be implemented. To start a drip plan, you need to finalize which form of DRIP will suit you. All three forms have their advantages and disadvantages. However, planning money is easier through a brokerage DRIP account. 

Opting for a company's DRIP plans will mean that you will have to opt for the DRIP plans of all the companies in your portfolio that offer them. Doing this will involve unnecessary work and planning and can be challenging to track, particularly if you have a diverse portfolio of shares. 

Opting for a DRIP plan offered by your broker will mean a one-stop option for your entire portfolio, and it will provide ease of use and monitoring. Many brokerages offer DRIP plans for fractional shares as well, unlike company plans. Another advantage of opting for a brokerage is that if a company doesn't offer a DRIP plan but does pay out dividends, you can set up a DRIP for it with your broker through a brokerage DRIP account. 

Every brokerage account follows its system for dividend reinvestment of stocks. You will have to refer to your broker's help page or customer support for guidance on how to open or set up a DRIP account. However, most have easy-to-use and online account setup procedures for quick activation of investment processes.

Suppose you opt for a dividend reinvestment plan (DRIP) for an individual company. In that case, you will need to get in touch with its investor relations department or representative to have your DRIP account set up by the company. 

Treatment of Taxes 

You have to keep in mind that regardless of how much or how little you spent on getting a dividend reinvestment plan on stocks, you will still be liable to pay taxes on the income. Paying the tax amount is usually not an issue for most people if you get a few (hundred) dollars extra. However, if your dividend income is higher, your tax payable will also increase, and you will be bound to pay the taxes on the dividend income you reinvested. Paying this usually means a cash outlay from your spending income.  This can be a concern for investors who reinvest all their dividend income into DRIP plans and tie up their funds. 

Some tax advisors recommend placing dividend stocks in investment accounts that offer tax benefits as an individual retirement account, commonly known as an IRA. 

IRAs are beneficial for savings as they offer tax advantages. An IRA grants their account owners exemption from paying income tax on any growth of their investments. This means that any amount paid into your IRA is tax-exempt. Don't get too excited! You will end up paying taxes at various stages. Payments into traditional IRA accounts can cut taxes in the present. However, you will be taxed on all withdrawals when you withdraw funds.  

Final Thoughts

For beginner investors trying to expand their portfolios by picking options that allow for portfolio compounding, a DRIP investing strategy is a sensible choice to make.  DRIP investment offers you subsidized shares, which yield more dividends, and then they pay more shares and dividends. Most DRIP plans also mean that you can benefit from share price increases in the market. 


power of dividend growth - photo
Figure 3. DRIP in the Long Run

While DRIP stocks signify rapid and compounded growth, they are more suited for people looking to build up a nest egg. For investors looking to generate an additional flow of income through dividends, a DRIP plan will not make much sense as it will eat up all extra income from dividends. 

DRIPs, however, are a popular means of expanding your investment into dividend stocks and can be added to a portfolio mix to increase compounding, reduce the cost of capital and allow investors to capitalize on the lower price of shares in DRIP accounts. 

The process of DRIP investment is straightforward and can allow for portfolio growth through easy reinvestment. To assess which shares will be a good choice for your DRIP plan, you can use the Gainy app's convenient features to compare and finalize options for your DRIP plan. 

FAQ

What is DRIP?

A DRIP is a Dividend Reinvestment Plan that allows shareholders to reinvest all their earnings from dividends into more shares. This provides for compounded growth in capital for investors. 

How to set up a dividend reinvestment plan?

Suppose company C has a DRIP program run by its transfer agent T. C offers all its registered shareholders the choice of placing all or a part of their dividend earnings into a DRIP plan. Investors will define their dividend reinvestment by a dollar percentage of dividend earnings or by the number of shares for reinvestment in shares. If shareholders don't specify a percentage amount or share amount, all their dividend income will be reinvested by T.

What are the disadvantages of a dividend reinvestment plan?

The only problem with a DRIP plan is if the share you opted for is facing falling prices, and you reinvest dividends further into a declining share. However, since a DRIP is for those looking for long-term investment options, temporary dips and falls in share prices are not a cause for alarm.

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