If you’re looking for a long-term investment strategy (or long-term shareholders for your company), it’s time to add a dividend reinvestment plan to your financial planning efforts.
What is a Dividend Reinvestment Plan?
To understand a Dividend Reinvestment Plan (DRIP), you need to understand dividend reinvestments. First, an investor buys into a stock that pays dividends (a profit-sharing payment usually delivered to the investor once per quarter). Dividend reinvestment, then, happens when an investor uses the payment to reinvest in the same company, rather than taking the dividend payout and spending it, saving it, or using it to invest elsewhere.
If that’s dividend reinvestment, what’s a dividend reinvestment plan? Simply put, a DRIP is a way of automating the reinvestment process. With a DRIP plan, investors don’t need to watch out for the dividend payment in their bank account and then manually purchase more shares of stock.
When investing, there are several types of plans from which you can choose:
Company-operated DRIP: Many large companies have a separate branch dedicated to managing investor relations, including DRIPs. When a company operates its own DRIPs, investors can purchase shares directly from the company itself. Because there is no need to pay a broker, many investors prefer this route.
Third-party DRIP: Smaller companies that don’t have the resources to form their own reinvestment program will often outsource to a third-party provider, who handles everything on behalf of the company. While the third party may charge a small commission for their services, this option is popular among many dividend-paying organizations.
Broker-operated DRIP: When companies do not have their own DRIP, investors need to go through a brokerage firm in order to set up their plan. Under this model, brokers purchase shares from the open market and, depending on their relationship with the investor, may or may not charge a commission.
What are the advantages of DRIPs for investors?
Average out dollar cost: Because of the opportunity to take advantage of dollar-cost averaging, DRIPs are a common choice for investors looking for long-term growth with low risk. With a DRIP, investors purchase shares at regular intervals which, over time, can help average out the share price, even as the market goes through slumps and peaks.
See the power of compounding: While you’ll need to be patient, DRIPs can help you significantly grow your investments without needing to provide more seed capital. When an investor receives a dividend payout, they reinvest it in additional shares. During the next payout, the investor will receive an even greater payout thanks to the additional shares that were purchased.
For example, according to Forbes, if you invested $10,000 in Pepsi back in 2010, that amount would be worth $28,800 by 2020, with the number of shares growing from 153.82 all the way to 206.4. In other words, you would have gained $18,800 and more than 50 shares without needing to contribute more capital.
Save on costs: Setting up a dividend reinvestment plan allows you to buy additional shares at a lower cost. Company-operated DRIPs do not come with brokerage fees, and in some cases, DRIPs offer new shares at a lower rate than the market price (usually between 1% and 5%).
Invest without all the effort: DRIPs are appealing to those interested in passive, long-term growth because reinvestments are executed automatically. Investors can streamline their investing strategy and increase their position without having to spend too much time managing their investments.
What are the advantages of DRIPS for companies?
Retain your capital: Companies deliver dividend payouts in the form of new shares, which means they are able to maintain their capital and reinvest it into the business itself.
Acquire long-term shareholders: Setting up a reinvestment program is an advantageous move for companies that want a loyal shareholder base. Investors interested in DRIPs are usually looking to invest long-term, and are less likely to sell their shares when the market declines.
How can you set up your own Dividend Reinvestment Plan?
Whether you’re a company or an individual investor, we’re here to work with you to determine whether a dividend reinvestment plan works for you or your business. Contact us today to learn more about how Ironwood Wealth Management can help you reach your financial goals.
