Dividend Reinvestment Plans: What They Are and How They Work
There are two main types of dividend reinvestment plans: brokerage account plans and company DRIPs.
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What is dividend reinvestment plan?
A dividend reinvestment plan is a system of using dividends to purchase more shares of the company that paid the dividends. It is an alternative to receiving the dividends in cash.
Is dividend reinvestment a good idea?
Dividend reinvestment, like any investment, has pros and cons. But reinvesting dividends can be a powerful way to boost your returns over the long term.
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How do I set up a dividend reinvestment plan, or DRIP?
There are two main ways to set up a dividend reinvestment plan:
Through the company that pays the dividends. You can invest directly in the dividend reinvestment plan, or DRIP, offered by the company you want to invest in, assuming it has one. You don’t have to have a brokerage account to do this.
Through a brokerage account. Many stock brokers will let you choose to reinvest your dividends rather than receive them as payouts.
Pros and cons of company DRIPs
Ease of purchase.
Potential savings.
Lower fees.
Potential tax advantage.
Potential delays.
Holding requirements.
Fees.
Complexity.
Concentration risk.
Pros of company DRIPs
Ease of purchase. You can purchase stock by reinvesting your dividends, and often, companies will let you buy additional stock on a fractional basis. That means you can buy small pieces of the stock with your dividend reinvestment, rather than waiting until you have enough to purchase a full share.
Potential savings. Companies sometimes offer their stock at a discount to the market price (in some cases, the discount is available only on the shares purchased through dividend reinvestment, not the optional cash purchases).
Lower fees. Some company DRIPs don’t charge commissions or fees to enroll or to buy shares.
Potential tax advantage. Some company DRIPs let you invest through your IRA. (See if automatically reinvesting your IRA dividends makes sense for you.)
Cons of company DRIPs
Potential delays. The companies may follow their own schedules for investing your money — it may be days between the time the company receives your “buy” request and the time it invests your money, and the same goes for selling shares. This could mean the price of the stock has fluctuated.
Holding requirements. Some companies require that you’re already a shareholder to enroll in a DRIP. One solution is to buy a single share from a broker and then ask the broker to register that share in your name (the broker likely will charge a fee for this service).
Fees. There may be enrollment and other fees, which often cost more than reinvesting dividends through a brokerage account. There’s usually a fee to sell shares as well. DRIP fees and terms vary, so it would be wise to do your research to find the best plans (and, of course, make sure the company is a worthwhile investment).
Complexity. Managing multiple company DRIPs may entail more paperwork than holding a single brokerage account.
Concentration risk. Company DRIP plans are solely for people who want to invest in individual stocks — and one specific stock, at that. This limits your ability to invest in other options that are available through brokerage accounts, like mutual funds or exchange-traded funds.
Pros and cons of brokerage account DRIPs
Ease.
Diversification.
Simplicity.
Potential purchase limits.
Cost.
Pros of brokerage DRIPs
Ease. You can access multiple investment types — individual stocks, mutual funds and ETFs, to name a few — from the convenience of one account.
Diversification. Because of the wider investment selection through brokerage firms, it's easier to diversify your holdings, either by investing in many dividend stocks or by choosing a mutual fund, which invests in many companies on your behalf.
Simplicity. It may be simpler to reinvest dividends through a brokerage account, which offers consolidated investment statements and a one-stop-shop for investing. (In company DRIPs, you have to track down the details of each company’s plan. Once enrolled, you’ll likely receive a separate statement for each DRIP you’re invested in.)
Cons of brokerage DRIPs
Potential purchase limits. Not all brokers offer fractional shares, but the practice is becoming more common. (Here's a list of brokers that offer fractional shares.)
Cost. Brokers don't offer stock at a discount. If you're investing in a company that discounts its shares through its DRIP plan, you may save money by enrolling directly with the company.
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Do I pay taxes on reinvested dividends?
Yes. it’s important to keep your records straight, because generally you owe tax on dividends in the year you received them, even if those dividends were immediately reinvested.
» MORE: How dividend taxes work
Key takeaways of dividend reinvestment
Reinvesting dividends can be a powerful way to boost returns over the long term.
That said, keep an eye on any investment in which you’re reinvesting dividends continuously over time — generally, investing too much in one place can add risk to your portfolio.
