The Perks Of Dividend Reinvestment Plans

Andrew Bloomenthal has 20+ years of editorial experience as a financial journalist and as a financial services marketing writer.

Michael Boyle is an experienced financial professional with more than 10 years working with financial planning, derivatives, equities, fixed income, project management, and analytics.

A Dividend Reinvestment Plan (DRIP) is a vehicle that lets shareholders reinvest dividends, in order to purchase full or partial shares of stock. Some of the most well-known publicly-traded companies offer DRIP programs, letting investors funnel as little as $10 back into their investments.

Key Takeaways

• A Dividend Reinvestment Plan (DRIP) is a vehicle that lets shareholders reinvest dividends, in order to purchase full or partial shares of stock.
• Company-operated DRIPs are commission-free because no broker is needed to facilitate the sale.
• Companies who find it too costly to directly run DRIP programs often turn to third parties, or transfer agents, who facilitate all of the DRIP details on the company's behalf.

Companies use DRIPS to sell small amounts of shares because it ultimately gives them low-cost access to more capital. When investors purchase a stock on an exchange, they’re essentially buying it from other investors, therefore the company sees no benefit from the sale. But with DRIPs, shares are bought directly from the company, which benefits from the proceeds reinvested under its own roof.

If a company itself operates a DRIP, it will set specific times throughout the year—usually on a quarterly basis, to execute DRIP transactions. Shares sold through DRIPs are taken out of the company's share reserve, and cannot be sold on the market. Therefore, when investors are ready to unload their DRIP shares, they must sell them back to the issuing company. These transactions do not impact the stock price of the shares in the market.

Alternatively, if DRIPs are operated by a brokerage firm, that entity simply purchases shares from the secondary market and adds them to an investor’s brokerage account. These shares are eventually sold back on the secondary market, at market prices. Consequently, brokerage-operated DRIPs have the same effect on stock prices as a normal buy or sell transaction in the open market.

How DRIPs Benefit Investors

1. Company-operated DRIPs are commission-free because no broker is needed to facilitate the sale. This appeals to small investors, who cannot afford high commissions.
2. Some DRIPs offer optional no-fee cash purchases of additional shares, directly from the company, usually at a 1%-10% discount. And with no commission fees, the cost basis of these shares is considerably lower than it would be if purchased outside of a DRIP.
3. DRIPs are flexible by nature, letting investors invest as little as $10 or as much as $500,000 at one time.
4. DRIPs employ a technique called dollar-cost averaging — averaging out the price at which investors buy stock as it moves up or down, over an extended time period. With this system, investors aren’t buying a stock either at its peak or at its low.

Types of DRIPs

DRIPS may be arranged in the following different ways:

1. Companies that operate their own DRIPs typically rely on their investor relations departments to handle all aspects of the plan, which sometimes lets individuals directly buy a share of the company to start a DRIP account, rather than going through a broker.
2. Companies that find it too costly to directly run DRIP programs often turn to third parties or transfer agents, who facilitate all of the DRIP details on the company's behalf.
3. Brokerages often spearhead DRIP programs, when they identify companies that lack this option. But such brokerages only allow for the reinvestment of dividends and offer no cash purchase option, and they only provide this service to customers who already use their account to make commissioned trades.

Getting Started with DRIPs

Starting a DRIP account requires some legwork by investors, who must first investigate which companies offer them, as not all do. The internet is a great resource for this search. Once it becomes clear which companies offer DRIP programs, it's essential to determine whether the plan is run by the company or a transfer agent.

Finally, investors must first buy shares in the company, in order to set up a DRIP account. To qualify for this program, DRIP operating companies often require shareholders to register their names on the stock certificates. This is not typically the case with brokerages, which register accounts in street name, as opposed to the shareholder's name.

How Taxes Affect DRIP Investing

Even though investors do not receive a cash dividend from DRIPs, they are nevertheless subject to taxes, due to the fact that there was an actual cash dividend--albeit one that was reinvested. Consequently, it’s considered to be income and is therefore taxable. And as with any stock, capital gains from shares held in a DRIP are not calculated and taxed until the stock is finally sold, usually several years down the road.

Bottom Line

DRIPs exhibit numerous traits that benefit both investors and companies alike. Becoming familiarized with DRIPs and participating in DRIP plans can add value to any investment portfolio.