Dividend ReInvestment Plans (DRIPs)
Dividend ReInvestment Plans (also known as Dividend ReInvestment Programs, or DRIPs) are a great tool for long-term investors. The compounding interest of DRIPs allows investors to purchase additional shares of stock at no cost -- simply reinvest the dividends, and when enough money is accrued, additional shares are automatically purchased.
How do dividend reinvestment plans (DRIPs) work?
When an investor enrolls in a dividend reinvestment plan, he will no longer receive dividends in the mail or directly deposited into his brokerage account. Instead, those dividends will be used to purchase additional shares of stock in the company that paid the dividend.
What are the benefits of dividend reinvestment plans?
Enrolling in a DRIP is fairly easy. Cash dividends paid by the company are automatically reinvested into additional shares. Once the investor has enrolled in a DRIP, the process becomes entirely automated and usually requires minimal attention or monitoring.
Many dividend reinvestment plans are often part of a direct stock purchase plan. If the investor holds at least one of his shares directly, he can have his checking or savings account automatically debited on a regular basis to purchase additional shares of stock, usually at no cost to the buyer.
The Fee to purchase through dividend reinvestment programs are normally small, if any. Dividend reinvestment plans also allow the investor to purchase fractional shares. Over decades, this can result in significantly more wealth in the investor's hands.
The results of reinvesting dividends
If you had $2,000 invested in Pepsi in 1980, that would be worth more than $150,000 by the end of 2004. You would have started with 80 shares, but by reinvesting dividends, you'd now have 2,800 shares.
If you had $2,000 invested in Philip Morris in 1980, that would be worth just under $300,000 by the end of 2004. You would have started with 58 shares. Today, thanks to stock splits and reinvesting dividends, you now would have more than 4,300 shares.
These are fantastic examples of compounding returns. The chart below also illustrates the long-term value of dividends reinvested.
* Ibbotson Associates ®
How does partial enrollment in a DRIP work?
Let's say that Thomas Henderson owns 500,000 shares of General Electric. The stock currently trades at $49.75 and pays an indicated annual dividend of $2.72 per share ($0.68 per quarter). William would like to receive some cash for living expenses but would like to enroll some of the shares in a DRIP. He calls his broker and has 300,000 shares enrolled in General Electric’s DRIP. When the quarterly dividend is paid, William will receive cash dividends of $136,000. He will also receive 4,100.5 additional shares of General Electric giving him holdings of 304,100.50 shares (300,000 shares * $0.68 dividend = $204,000 divided by $49.75 per share price = 4,100.5 new shares of General Electric).
Example of full enrollment in a DRIP program
Let's say that Mary Johnson owns 1,000 shares of Pepsi. The stock currently trades at $50 per share and the annual dividend is $0.88 per share. The quarterly dividend has just been paid ($0.88 divided by 4 times a year = $0.22 per share quarterly dividend). Before she enrolled in Pepsi’s dividend reinvestment plan, Mary would normally receive a cash deposit of $220 in her brokerage account. This quarter, however, she logs into her brokerage account and finds she now has 1,004.40 shares of Pepsi. The $220 dividend that was normally paid to her was reinvested in whole and fractional shares of the company at $50 per share.
Key Lessons in This Chapter
- When you enroll in a DRIP, your dividends are automatically reinvested back into more shares of the stock.
- The true beauty of DRIPs lies within the compounding returns they can provide -- a relatively small amount of shares can grow into a very large amount over the long term, even without future purchases.
- When enrolling in DRIPs, you can choose partial enrollment (where a portion of the dividends are returned to you in cash), or full enrollment (where all dividends are reinvested into more shares).
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