In regards to investing it’s not the drip coming from your faucet or shower!
DRIP is an acronym for Dividend Reinvestment Plan. DRIP is a plan offered by some corporations that allows shareholders of their stock to reinvest the dividends earned into purchasing additional shares of the company’s stock.
Unlike open market based trading that requires investors to purchase a “whole” share of a company’s stock, DRIP allows stockholders to purchase fractional shares from the same company without trade/commission fees.
For example, if XYZ Company’s shares are selling for $10 and you wanted to purchase a single share you could purchase a share via a brokerage firm, or online trading resource like E*TRADE. In addition to the cost of the share ($10) you would probably pay a transaction fee for the purchase of the share, like $7.95.
If XYZ issues a dividend for your ownership of its stock, let’s say $1 per share you have the choice of receiving the dividend in cash, or you could reinvest the dividend back into XYZ to purchase additional stock.
- What is a Dividend?
- What is a Stock?
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However, a $1 dividend will not purchase a full share of stock valued at $10. In this situation, because the company provides a DRIP program they would issue you a fractional share of stock – in this case your $1 dividend would allow you to purchase 1/10 of a share of stock.
Why would a company offer a Dividend Reinvestment Plan?
The primary reason a company offers a DRIP program for its investors is because it returns their dividend payout (money) back into the company in the form of stock. Versus you taking the cash dividend and purchasing another companies stock. The additional purchase of stock through the company represents more capital for the company to use. In addition, DRIP programs have been shown to provide a level of “stickiness” toward the ownership of the company’s stock – i.e. stockholders participating in a DRIP program are less likely to sell the company’s shares.
What does it mean to an Investor?
As an investor DRIP programs provide two distinct advantages.
- Reinvesting dividends allows you to purchase additional shares of the company stock without a transaction or brokerage fee.
- It provides a simple growth strategy for accumulating more shares of the company’s stock. When dividends are consistently reinvested in the company to purchase more shares the investor realizes a consistent gain (growth) in the number of shares they own.
DRIP is often part of a common investment strategy known as a Dividend Growth Strategy. A dividend growth strategy is one where an investor’s primary focus is to make money off companies that provide a dividend. By focusing on companies that provide a dividend and then reinvesting those dividends to purchase more of the same stock, the investor makes money from the dividend and the accumulated growth of stock shares. The goal is to accumulate more shares as the company’s stock price rises.
DRIP is an option for reinvesting your dividend payments when you don’t want to receive those payments in cash.
If you would like to find out which companies offer a DRIP program contact your financial consultant or you can find more information from asset management companies like Fidelity and Vanguard. Online brokerage firms like Etrade, TD Ameritrade and TradeKing are also a resources.
Do you participate in a DRIP program? Comment below.