Dividends are
good investments. And you can make them extra special if you know what to do
once you have laid your hands on them. You can reinvest them! A dividend
reinvestment plan, or DRIP, is what you need. And while we’re at it, we’ll tell
you the perks you can get from reinvesting your dividends.
Drip, drip, drippin'... What’s
DRIP?
As implied
above, dividend reinvestment plans are a way for investors to reinvest variable
amounts in a company. If you reinvest dividends, you can buy shares or
fractions of shares (that is, if the dividend amount is less than the value of
one share) of some of the most well-known, publicly-traded companies.
Rather than
giving the investor a quarterly dividend check, the company that runs the DRIP
uses the money to purchase shares of the company (in the name of the investor).
If the
company is the one operating the DRIP, it usually sets specific times in a year
when the purchase of shares by shareholders in its DRIP program is allowed. They
usually do it quarterly. The company generally does not go into the secondary
market and buy the shares and then sell via the DRIPs.
The shares
sold via the DRIP are brought out of the company’s reserve, and you cannot sell
the DRIP share on the market. If you’re ready to sell your DRIP shares, you
must sell it back to the company that issued it. Of course, you’ll follow the
current price.
If a
brokerage firm operates the DRIP, the brokerage buys shares for you from the
secondary market. They then add the shares to your account, and these shares
will be eventually sold back on the secondary market.
What’s in
it for you?
DRIPs are
quite beneficial for many investors and traders. For one, company-operated DRIPs are
commission-free. This is because you don’t need any broker to facilitate the
trade. This one’s extremely appealing to new investors, who would have to save
up funds for a long time just to make the usual brokerage commission fee become
a small enough portion of their purchase amount.
In addition,
some DRIPs offer optional cash purchase of additional shares coming directly from
the company. These cash purchases usually come at a 1-10 percent discount
without fees.
You must
also consider that DRIPs are flexible. You
can invest small or large amounts, depending on your financial position. Some DRIPs
enable investors to contribute as little as $10—or as much as $500,000 at one
time.
Further,
DRIPs utilize dollar-cost averaging, which is the process of averaging out the
price at which you buy a stock while it moves through peaks and valleys over a
long period. What does this mean for you? It simply tells you that you don’t
have to buy a stock right at its peak or low.
Lastly, some
drips offer the stocks at a discount from its spot price in the market. You
might get a discount ranging from 1 percent to as much as 10 percent. When
fused with zero commission fees, the cost basis of these shares for you can be substantially
lower than it would be if you bought it outside a DRIP.
Want to learn more about stocks? Read Picking Stocks: 4 Things to Consider
What’s in
it for the company?
If you’re
curious, you might be asking yourself, “Why would a company bother with selling
a couple of shares here and there?”
For a
simple answer, the advantage is that DRIPs offer low-cost access to capital. When
you buy a stock on a stock exchange, you are practically buying it from another
investor like you, and that means the company doesn’t have any benefit from
that transaction at all. DRIPs are different, though. The DRIP shares are
bought directly from the company. Then, the funds obtained from the purchase
are then reinvested into the company.
Moreover,
companies also benefit from DRIPs because they want a stable shareholder base
that has a long-term investment style.
If you
become a DRIP investor, you are unlikely to run for the exits when the markets
start to frown at you. This is partly because DRIP shares are less liquid than
shares in a regular brokerage account, as well as in the secondary market.
Selling DRIP
shares costs you a little more time and effort than just talking to your broker
over the phone. Keep in mind that if shares are from the DRIP operated by the
company, these shares need to be bought back by the company. In other words, easy
sales stuff are allowed, unlike in the general stock markets.
Read more about DRIPs! Learn about its Advantages and Disadvantages!
Final
Word
Well, that’s
just for starters. There are still a lot to learn about DRIPs. For now, you
just have to remember that DRIPs are a good way to use your dividends. Determine
first if you think this one’s good for you, and then do some research about the
inner workings of different DRIP operators.
For further reading, check Shares and Dividends
Test
your skills in stock trading at FSMSmart! We will provide you with daily
market updates and help you stay up-to-date with economic
events. Register for an account now!
