What Is a DRIP?

4 mins read
by Angel One

Most people know that shareholders are privy to unique benefits like dividend pay-outs. However, there are dividend reinvestment programs that use these pay-outs to strategically grow one’s wealth. Curious to know more about DRIP investing and DRIP stock? Here’s what dividend reinvestment plans mean for investors.

What is dividend reinvestment plan (DRIP)?

Dividend Reinvestment Plans, otherwise shortened to DRIP, is when an investor who receives dividend pay-outs in cash reinvests those pay-outs into more stock, thereby allowing the company’s investment to grow over time. DRIP uses a technique that’s known as rupee-cost averaging which enables one to average out the amount at which one buys a stock since its stock price will move up and down. The core benefit of DRIP is that they can aid in investors amassing more shares without any brokerage fees or commissions.

How Does DRIP Work?

By reinvesting their cash dividend, investors can buy shares commission-free in a company’s stock. This dividend is a form of reward for shareholders which can come as a check, direct deposit, or cash to investors. The shares that were invested in are from the companies directly. In fact, companies often allow shareholders the opportunity to reinvest the cash amount of dividends issued into even more shares through a dividend reinvestment plan. These shares typically come from the reserves of the company itself. In other words, the stock exchanges do not offer these shares.

Benefits of reinvesting dividends

Now that we know the answer to what is DRIP, and how it works, there are also many advantages of using a DRIP. In fact, there are benefits afforded both to investors and to companies who buy DRIPs.

Benefits of reinvesting dividendsfor investors

DRIPs use a technique that is popularly called ‘rupee cost averaging’ where the intent is to even out the price at which the stock is bought since it constantly moves up and down over a long period. Hence, with rupee cost averaging in the works, you will not be purchasing a stock that is at its ultimate low or at its peak price. DRIPs that are company-operated are a popular choice among shareholders as a low-cost option so they can accumulate extra shares.

Another benefit of DRIPs for investors is that they are quite flexible. An investor can invest varying amounts of their dividend back into the company’s stock. Oftentimes, there aren’t any commissions or brokerage costs involved with DRIPs. In fact, many companies offer shares through their dividend reinvestment programs at a price that is discounted.

It is usually 3%-5% lower than the current market price of the share. The combination of no trading fees along with a discount in the share price allows an investor to significantly lower their cost basis when it comes to owning a company’s shares. The result of this is that DRIPs can aid investors in saving money when it comes to buying extra shares of a company’s stock. Had they bought them on an open stock exchange, they would be subjected to the market price and trading commissions.

Benefits of reinvesting dividendsfor Companies

Now we come to the benefits of reinvesting dividends for the companies that are offering these programs. Companies that enable DRIP investing by offering a dividend reinvestment program catch the attention of investors. When investors decide to put their money into these programs, they receive a capital investment in cash from shareholders. This capital that comes from investors investing in DRIP stocks can now be reinvested into the company’s operations. Companies can use that capital to reinvest back into the company.

Keep in mind that shareholders who are part of the company’s dividend reinvestment plan are also not as likely to sell off their shares in case the company has one bad report showcasing earnings in a falling market. This means that these investors are loyal and prepared to stick with the DRIP program for the long term.

The Bottom Line

Dividend reinvestment plans exhibit numerous characteristics —flexibility, rupee cost averaging, low cost, wealth creation — that are advantageous to both investors and the companies that offer DRIP stock. By becoming familiar with dividend reinvestment programs and adding one or two to one’s investment portfolio, one can make entry into a long-term investment position in a company’s stock.