Dividend Reinvestment Plan (DRIP)

It automatically reinvests income from a stock's dividends to buy more company shares

Investments aim to maintain, ideally increase, the value of the original amount you put in. Dividend reinvestment plans, also known as DRIP, or DRP, enable your money to work for you. 

Dividend Reinvestment Plan (DRIP)

When you receive a dividend, there are two options of what to do with the money: cash out or reinvest.

Without enrolling in a dividend reinvestment plan, cash from dividends will be sent directly to your bank account or as a check.  

This plan automatically reinvests income from a stock's dividends to buy more company shares. This transaction occurs on the dividend payment date of the company (this could be quarterly, biannually, or annually).

The cash dividends can be reinvested in additional or fractional shares, depending on the stock's current market price.

As of 2020, over 1,000 companies offer some form of a dividend reinvestment plan, double the number of companies that offered a DRIP a decade ago.

The shares purchased through a company's DRP generally come from the company's reserve and, therefore, are not marketable through stock exchanges such as the New York Stock Exchange (NYSE).

As a result, some DRIPs require a minimum purchase (such as $10) because shares are generally commission free and come at a considerable discount to the current market price of the stock. 

They do not come with additional fees from a brokerage or the company. However, reinvesting dividends must still be reported as taxable income despite not directly receiving the cash. Some exceptions include tax-advantaged accounts such as an IRA.

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The reinvestment of cash dividends can help you capitalize on the power of compounding. Compounding results from the accumulation of shares over time, each pays a premium that will be reinvested on every dividend payment date.

There are three types of DRPs:

  • Through the company 
  • Through a brokerage
  • Through a third-party transfer agent

This article will help establish if a DRP suits your investing goals. DRPs are alluring to long-term investors because compounding requires a long time horizon.​​

Types

Dividend reinvestment plans can be a wise method of repurchasing new shares of a stock, but the fees and accessibility of the program can vary depending on the company.

The decision to set up a program is at the company's discretion; if they do not want to set one up, brokerages and third parties often will. 

Many publicly traded companies offer a reinvestment plan in some way.

You can deposit the dividend income into your brokerage account and manually purchase additional shares if a stock does not have a reinvestment program.

Meeting

1. Company-Operated Reinvestment Plan

Many large, publicly-traded companies have their DRP managed by their investor relations team.

The company has its reserve of shares purchased by shareholders through reinvestment and generally comes at a significant discount. 

Additionally, these plans have no commissions because the intermediary, the broker, is removed from the transaction process.

This is appealing to long-term shareholders because there is no commission on each reinvestment which can occur multiple times a year depending on how often a company pays out its dividend. 

This allows shareholders to capitalize on compounding without paying fees.

2. Broker-Operated Reinvestment Plan

Unlike the company-operated program, the broker acts as the intermediary. This can be advantageous if the company does not have its own DRP, but you still want to reinvest the dividends. 

Your brokerage buys the shares on the open market to reinvest your dividends.

However, your broker may or may not charge a commission for this service, so it's essential to research associated fees with broker-operated DRPs. 

Enrolling in a reinvestment plan through your brokerage can also simplify the process. Unlike the company-operated DRP, you will not have to activate automatic reinvestment for every individual stock.

3. Third-Party-Operated Reinvestment Plan

This type of DRP occurs when the company outsources the reinvestment of dividends to a third party. 

Companies may do this if running their own DRP is too costly or time-consuming for their investor relations team. This is usually the case with smaller companies.

This service may come with a fee or commission similar to a brokerage-operated DRP.

How to set up a dividend reinvestment plan

You must sign up for all three types of reinvestment programs as you will not automatically be enrolled.

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1. Company-Operated DRIPs

When there is a specific company you would like to set up a DRIP with, go to their investor relations page. On this page, the company will outline what its reinvestment plan is.

For example, this is the page you would visit if you wanted to set up the plan with Boeing Company.

2. Broker-Operated DRIPs

On your brokerage account, you can enable dividend reinvestment for all stocks with the option rather than through each company. At the same time, this is the most convenient option; research if there are fees associated with this service. 

For example, this is the page you would visit if you were looking into a DRIP through Vanguard. This page explains the plan's reinvestment plan, eligibility requirements, and a few FAQs.

Many of the large brokerage firms do not charge a commission or fees.

3. Third-Party-Operated DRIPs

With third-party companies, go to their website and find the dividend reinvestment form. You must fill out this form for each dividend stock you want to set up a DRIP.

For example, Computershare is one of the most popular third-party companies.​​

Examples

For instance, let's say that you own 1,000 shares of International Business Machines (IBM), and the stock currently trades at $100 per share. The quarterly dividend is $0.20 per share, so the annual premium is $0.80 per share. 

IBM

Before setting up a DRIP for IBM, you received $200 (1,000 shares * $0.20) as a cash deposit into your brokerage account from the dividend. 

However, with the plan, you would now own 1,002 shares of IBM. This is because the $200 would be reinvested to purchase two more shares of IBM at $100 per share. Note that if the dividend were not precisely $200, there would also be a purchase of fractional shares.

A similar pattern would occur each fiscal quarter that you receive a dividend, so the number of shares you have will increase exponentially. 

On the other hand, a real-world example is if you had invested $2,000 in Pepsi in 1980 and had enrolled in a DRIP. That $2,000 would be worth more than $150,000 by 2005. The 80 shares you started with would also have become 2,800 in 2005.

Advantages and Disadvantages

Like many investing techniques, there are advantages and drawbacks to enrolling in a reinvestment plan.

Consult your investing profile and current financial situation to decide if a DRIP suits you.

For example, if you are retired, you may want the dividend income deposited into your checking account to pay bills.

Advantages for Investors

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  • Many large companies offer a discount on the market price for shareholders that are enrolled in the plan. For example, some companies offer between 1% and 10% off the market price.
  • These help investors capitalize on compounding, allowing the investment to grow exponentially faster.
  • Many reinvestment programs do not charge a commission, so shareholders can save on transaction costs with DRIPs. 
  • Many DRIPs allow fractional investing, enabling every dollar to work for you in the market.
  • The reinvestments are automated once you set up a DRIP, making reinvesting accessible and easy. This automation also removes emotions from the investment decision, which can be a lot of investors' Achilles heel. 
  • These can reduce your risk because of dollar cost averaging. In addition, consistent investment over time despite the market conditions eliminates the need to time the market to ensure you don't have the security at too high a price.

Advantages for Companies

  • Reinvestment plans can establish a base of loyal shareholders with a long investment horizon. This can alleviate some of the stress of poor performance because these investors will likely not sell their shares despite increased volatility.
  • DRPs can generate more capital for a company when it sells shares where the dividend cash is reinvested.

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Disadvantages for Investors

  • Shares can be slightly diluted due to DRPs because more claims become outstanding in the market when more shares are sold. Investors who do not enroll in a reinvestment plan could see their ownership diluted.
  • As a result of the automatic reinvestment on each dividend payment date, the investor has no control over the price they pay for the stock. 
  • It can be time-consuming and sometimes challenging to keep track of the dividend income for tax reporting purposes.
  • An individual's portfolio may need constant rebalancing if a few dividend companies dominate their portfolio and they want to maintain their diversification. Additionally, consistent selling of a stock can have more tax implications.
  • Some reinvestment programs come with a fee, including some broker-operated DRPs and third-party-operated DRPs.
  • Shares purchased directly through a company are from their reserve, not the market, so the claims will have to be sold now to the company, decreasing liquidity.
  • Some DRPs require a minimum investment (either a dollar amount or a specific volume of shares).

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Researched and authored by Jackson Hartz | LinkedIn

Reviewed and edited by James Fazeli-Sinaki | LinkedIn

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