What Is DRIP Investing?

Daniel Penzing
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How Did DRIPs Start?

The primary reasons that corporations were reluctant to split their stock were (1) doing so would increase the number of stockholders, thereby increasing administrative costs and (2) the cost of executing a stock dividend, or stock split.

Although it might appear as if there’s no such thing as a free lunch, DRIPs proved just that. Stock splits were implemented to reward shareholders who had not sold their shares. Plus, the additional shareholders did not materially affect the costs to the corporation. So the shareholders were rewarded with a lower stock price for the same intrinsic value in the shares.

Governments are sensitive to the participation of their citizens; hence the IRS was receptive to a plan that would increase the number of stockholders to increase tax collections. In 1962, the IRS worked out the details of a new way to increase the stockholders.

As a result of the stock market crash of 1929, the vast majority of stockholders held onto their stock. The number of stockholders dropped off significantly in the late 1940s, and as a result, the number of shareholders was expected to remain stagnant for years to come. This made stocks a poor choice for investors hoping to grow their wealth. It also made already high tax collections potentially even higher.

How Do You Start DRIP Investing?

The term, DRIP, stand for “Dividend Reinvestment Program.” It is a program offered by many companies where you can reinvest your dividend income at a discount. It’s totally free, and the companies pay the fees.

2 Ways to Start a DRIP Account

  1. Call the company: Many companies offer DRIP accounts. Call the company you invest in and ask about the possibility of opening a DRIP account.
  2. Set it up on your own: In some cases, the companies have a form for you to set up a DRIP account. Other times, you can set it up directly from your online broker.

Making Your First DRIP Purchase

After you have set up your DRIP account with your online broker, you can make your first purchase. It will occur 2 days later, but you can purchase shares directly through your brokerage account.

Your broker will look at the market price of the stock (which is lower than the per-share price of the stock because of the DRIP discount), and then add the appropriate amount of money to your DRIP account.

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How to Purchase a DRIP?

Buying into DRIP stocks offers two best benefits, which is why it is such a popular investment option for income, and usually for those people nearing retirement. Once you sign up for a DRIP, you have the option of posting a check once a month or a quarterly check. Although you can go online to make a DRIP purchase or to view your current account balance, the whole beauty of DRIP stocks is that you can purchase a large number of shares without paying a percentage of them. If you don’t choose to make a purchase in one month, then it will be applied to the next month.

However, sometimes your purchase will be charged an interest fee until the following month, so this is another reason why it’s so important to understand the terms before you sign up.

What Companies Offer DRIPs?

DRIPs are a great way to own stocks. They are easy to set up and can offer long term value. DRIP stands for “Dividend ReInvestment Program.” When you invest in a DRIP, you are doing two things at the same time — investing in the company and reinvesting your dividends. The two complement each other and as a result, DRIPs are generally more cost effective than purchasing stock outright. This benefit can amount to big savings over time.

With DRIPs, the dividends that a company pays to its shareholders are automatically reinvested without the shareholder needing to do anything. That's a valuable benefit for many investors who would otherwise have to do a lot of paperwork to purchase shares. Investors who automatically reinvest their dividends not only end up owning more shares over time but also put themselves in a position to earn compounding interest and save on brokerage fees.

Because the costs associated with DRIPs are generally less than the costs when purchasing shares, DRIPs can be more cost-effective over time. Research released in March 2014 revealed that 4.8 percent of U.S. households were invested in DRIPs, a number that has more than doubled since 2010. As more companies and advisors educate shareholders about the advantages of accounts that automatically reinvest dividends, that number can be expected to increase significantly.

What Are the Advantages of DRIPs?

Saves you money. If you buy shares of a stock you plan to hold onto for a long time, it’s highly likely that you will lose 20% or more in commissions. This is because most brokerages charge a commission for each transaction, regardless of the number of shares you purchase.

Accessibility. Certificates are usually only good when you own them outright, but your brokerage can readily cash a dividend check for you.

You can use up spare cash.

Flexibility. You can purchase fractional shares. This is a boon for anyone who doesn’t have an endless supply of cash to spend.

A DRIP can be a great fit for almost anyone, but especially for long-term investors. You’re providing your brokerage with an ongoing, automatic means of reinvesting your dividends.