A dividend reinvestment plan, also known as a DRIP, is a plan that allows investors to reinvest their cash dividends in shares or fractional shares of the dividend-paying company. This action takes place at the dividend payment date. In most cases, the DRIPs allow the shareholders to acquire shares commission-free. And in some cases, the company will offer the shares at a discount to the current share price.
Difference between a Dividend Reinvestment Plan and a Dividend
Most shareholders receive their dividend payment in the form of a cash payment or a payment into a direct deposit account. If the shareholder has an account at a brokerage firm, the cash payment will be made to the shareholder’s brokerage account.
If the shareholder opts for the dividend reinvestment plan, the shareholder will receive the shares or the fractional shares from the company’s own stock reserve. Therefore, that stock is usually not available through a stock exchange. Though the shareholder never actually takes possession of the stock, they must report it as taxable income. Not all companies offer a dividend reinvestment plan. However, many brokerages will allow you to reinvest your dividend payment in any shares that shareholder has in his investment account.
For the shareholder, there are many advantages to choosing a dividend reinvestment plan. One of the biggest advantages is the ability for the shareholder to accumulate shares of the stock without having to pay a commission. Also, some companies offer a discount when shareholders opt into a DRIP. That discount can range from 1% to 10% of the current share price. When you combine the company discount with the lack of commission, the benefits for a long-term shareholder can be significant.
Over the long term, the shareholder gains a huge advantage when you factor in the compounding returns. This is especially the case if the company regularity increases the dividend payment. If the dividends are increased, then that increases the number of shares the shareholder can receive in a DRIP plan.
In addition to the shareholder, the company also has some advantages for participating in a dividend reinvestment plan. The biggest advantage is the capital the company can gain when shareholders use their dividend payments to acquire more shares. The other big advantage for companies is that a shareholder is less likely to sell a stock that is participating in a DRIP plan.
Automatically reinvesting dividends is a powerful strategy. To learn more about dividend investing, check out our dividend investing articles.