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What is a Dividend Reinvestment Plan?

KD Morgan
KD Morgan

A dividend reinvestment plan is an excellent way to “play the market.” These investment plans are often referred to as a DRIP or DRP. The acronym also implies “dripping,” or slowly increase your position in a particular stock.

Many companies offer a dividend reinvestment plan as a means of purchasing additional shares of their stock. This allows the shareholders to purchase stock without going through a broker. In most cases, by buying directly from the company, it also eliminates the commission or stock purchase fee.

Businesswoman talking on a mobile phone
Businesswoman talking on a mobile phone

The companies that offer the dividend reinvestment plan have several different options available. Some offer an automatic reinvestment of the dividends received. These are usually offered every quarter as the dividends are paid. Other options offer a monthly purchase of additional stock or an on-demand purchase. In most cases, the stock will be offered from 1% to 10% lower than the current market price.

Another advantage of a dividend reinvestment plan is that you can invest small amounts into the market at a time. Eliminating a large cash requirement allows people who do not have a lot to invest to be able to have an interest in the stock market. It also automatically engages you in dollar cost averaging.

While there is a very low minimum to a dividend reinvestment plan, there is usually a restrictive upper limit. However, the maximum amount allowed per quarter usually runs far into the thousands of US-dollars.

When purchasing stock on a regular, monthly basis, the number of shares accumulates rapidly. Normally the money you are contributing or the money you would receive from a dividend would not amount to much and would be lost. Therefore, a dividend reinvestment plan is an excellent way to purchase additional shares and increase your portfolio in a painless fashion.

Companies that offer a dividend reinvestment plan have one of several different programs available. A company-run dividend reinvestment plan operates their own program. These corporate programs are put in place as a shareholder benefit and usually are free of any charges. Some dividend reinvestment plans are available from companies that do not even have a dividend payout on their stock but just offer their shareholders a way to purchase more stock in low quantities.

If the complexities of a dividend reinvestment plan become too cumbersome, a company may choose to hire a transfer agent to run the plans. Many financial institutions run the dividend reinvestment plan programs of numerous companies as a side business. Most of these will charge a fee, which is lower than a brokerage commission. By packaging these plans together, they can use the same resources and offer good, competitive rates.

In order to be competitive, most brokerage houses allow their clients to reinvest their dividends at no extra charge. This dividend reinvestment plan only applies to purchasing stock with the funds from dividend payouts. This does not apply to new cash purchases of the stock.

If you are looking for long-term growth in the stock market, considering a dividend reinvestment plan is a good option. The one thing you need to do is to periodically reevaluate your stock to be sure that you want to continue to own the stock. If the answer is yes, a dividend reinvestment plan will serve you well.

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