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A dividend reinvestment plan (DRIP) refers to an investment feature in which shareholder dividends are automatically reinvested in stock of the same company. This reinvestment happens in lieu of a quarterly cash dividend payment (The income is still taxed). Often DRIPs will feature added benefits such as discounted shares and coverage of broker’s fees. This practice in turn allows the company to raise capital without holding a new public offering. It also benefits the company by decreasing the likelihood a shareholder will sell during a drop in the market: shares purchased in DRIPs are somewhat less liquid, and encourage long-term growth.
DRIPs are a good way to slowly accumulate stock in a company over time on an automatic basis. This facet makes them similar to automatic investment plans. In this case, dividend income is automatically invested without the shareholder having to make a choice each payment. As shares increase, dividends increase, creating a compounding effect, increasing total return potential. Since the investments occur periodically, the shareholder is able to take advantages of fluctuations in the market, as opposed to investing a large amount of money at one time. Since many companies today offer DRIPs, an investor can still take advantage of the feature while maintaining a diverse portfolio. DRIPs can also be set up through brokerage firms if not offered by the company.
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