Dividend Reinvestment Plans (DRIPs)

Dividend paying stocks are those in which a company distributes a portion of its earnings to shareholders. If you own dividend paying stocks, you can get extra money from the company whenever dividends are paid. (This is usually done quarterly, but can be done monthly, semi-annually or yearly.) Some people use dividends as income, providing for themselves a passive income stream. Others, though reinvest their earnings. One of the easiest ways to do this is through dividend reinvestment plans (DRIPs).

Dividend reinvestment plan

A dividend reinvestment plan (DRIP) is one in which dividends earned are automatically used to buy more shares of a company. Let's say you own 100 shares of a company, and the stock is worth $10 per share. Your company pays you a quarterly dividend of $20. Instead of pocketing that money, if you are signed up to participate in a DRIP, that $20 is used to buy you two more shares of the company. You now have 102 shares, and you did not have to come up with any additional capital outlay of your own. If the stock price goes up to $30 a share in the future, instead of getting $3,000 when you sell, you will end up with $3,060. You end up with $60 extra by participating in a DRIP.

Reinvesting with mutual funds and brokerage accounts

Many mutual funds offer automatic reinvestment of dividends. In fact, it may be that mutual funds that you invest in simply reinvest any dividends paid from holdings automatically. That can lead to increased investments without you having to do too much.

When setting up dividend reinvestment on individual stocks with brokerages, however, you may need to be more careful. Dividends paid show up in your brokerage account as cash, which means you have to reinvestment them yourself. This can lead to regular transaction fees when you buy more shares. You can void these fees if you do your research and sign up for accounts at brokerages that allow reinvestment at no extra charge (many brokerages have this feature).

Also, remember that you may need to pay capital gains taxes on dividends that you earn. This trips up many mutual funds investors during years that the market is down. It is a good idea to speak with a tax and/or investment professional to understand what you obligations might be.

DRIPs can be great tools to help you increase your wealth. Just make sure that you understand the risks and expenses that come with them.

Disclaimer: I am not an investment professional. This should not be construed as investment advice. All investment carries the risk of loss. Before investing, do your own research and/or consult with an investment professional.