DRIP Investing (Dividend Reinvestment Plans)
The term DRIP is an abbreviation for dividend reinvestment plans, which offer investors the opportunity to reinvest all, or a portion, of their dividend payments back into a company's stock. Oftentimes, companies will allow investors to purchase additional shares of stock through these programs too.
What is DRIP Investing?
Dividend reinvestment plans are sponsored by companies that allow individual investors to purchase common stock without going through a broker. The name comes from the plan's policy of allowing the investor to automatically reinvest dividends to purchase additional shares of stock.
Many DRIPs are offered to investors free of any participation costs, while others charge relatively small administration fees or commissions. While the name implies these plans are limited to reinvesting of stock dividends, some plans allow participants to directly purchase a company's stock. This enhanced practice is sometimes referred to as optional cash purchases, or OCPs.
A large number of companies offer dividend reinvestment programs, and participation rules are usually outlined in the investor's section of the company's website. Since these plans are flexible enough to allow even small purchases without a broker's fee, it's hard to find any downside to these offerings. In fact, there are several significant advantages of these programs including:
- Low Cost of Entry: investors don't need a lot of money to enroll in these programs, most companies allow the purchase of just a single share of stock, and often this purchase is at a discount.
- Cost Effective: since the investor isn't paying brokerage fees, all of the money is put to work. Over 100 companies allow investors to purchase stock at a discount to the current market price through optional cash purchase plans, or OCPs.
- Dollar Cost Averaging: finally, many of the DRIPs allow investors to purchase stock through automated weekly or monthly deductions. This long-term purchase strategy provides the investor with a less painful, and more structured, approach to buying stocks.
Generally, there are three ways investors can participate in dividend reinvestment plans:
- Company Run Plans
- Transfer Agent Plans
- Brokerage Plans
Company Run Plans
Many companies run these programs through their investor relations or shareholder services departments. Several companies have even started to offer Individual Retirement Accounts in addition to their reinvestment plans. Companies may have participation rules that include owning at least one share prior to joining the dividend reinvestment plan. They may also require the stock to be in the investor's name rather than street name. A phone call to the shareholder services department is an effective way to learn about company-specific participation rules.
Transfer Agent Plans
Due to the overwhelming popularity of some DRIPs, companies may engage the help of transfer agents to administer their programs. The transfer agent is a third party broker that typically runs plans for many different companies. Since the transfer agent is running multiple programs using the same resources, they can do it more cost effectively than some of the issuing companies.
While dividend reinvestment programs reduce the fees collected by traditional brokerage houses, many of these firms now attempt to mirror DRIPs by offering the ability to reinvest dividends without charging a fee. Unfortunately, these plans usually lack the most attractive feature of a real DRIP: The cash purchase of new shares of stock without fees.
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