DRIP investing: what is a dividend reinvestment plan?

If you’re searching for a solid way to build consistency within your investment portfolio, then DRIP investing is a solution worth checking out. But, before you go ahead and start tinkering with your investments, it’s important to understand how this system works and figure out if it will suit your investing style.

What does ‘DRIP’ stand for?

‘DRIP’ stands for ‘dividend reinvestment plan’. It’s a method of investing that’s particularly useful for building wealth over the long term. Potentially, it can help boost your returns over the years.

What is DRIP investing?

This popular investing strategy involves reinvesting income generated by an investment. So, when you hold stocks or shares that pay a dividend, the money is immediately used to buy more whole or fractional shares.

Traditionally, DRIP investing was organised directly through a company when you bought the stock. Nowadays, you have more flexibility with your dividends, controlling things yourself or with the help of your brokerage.

What are DRIP stocks?

These are individual stocks, exchange-traded funds (ETFs), or mutual funds you can buy that will automatically reinvest any dividend income into the original investment by purchasing more shares.

Some public companies don’t offer a DRIP service, but there are brokerages and investing platforms that can arrange this for you. With some share dealing accounts, you’re also able to reinvest dividends manually for a low cost or for free on a few platforms.

How does dividend reinvesting work?

There are two common ways you can automatically recycle your dividends and use them to increase your original position in a stock:

1. Direct DRIP – it can be possible to set up a dividend reinvestment plan directly with the company you are investing in. This is the traditional method but the least flexible.
2. Indirect with a brokerage – you can also arrange to set up a DRIP plan through your brokerage account. This saves dealing directly with a company and can provide more flexibility for your DRIP options.

Is a DRIP a good investment?

They can be, but there are no certainties. Immediately reinvesting any income from your investments allows you to automate the process of compounding. So, rather than having to keep doing this manually, DRIP investing removes the responsibility from your shoulders. It also reduces the chances that you’ll make knee-jerk reactions and poor investing decisions because you’ve made a commitment.

However, it’s important to remember that even though a dividend reinvestment plan can be a solid long-term strategy, it’s not foolproof. If the underlying stock performs poorly, the share price can fall and dividends can be cut or stopped altogether.

What are the advantages of investing in DRIP stocks?

There are loads of useful benefits for long-term investors who subscribe to a DRIP strategy for dividend stocks:

• Automates the reinvestment process, saving you time and energy.
• Allows you to benefit from dollar-cost averaging, buying more shares at various price points.
• It means that you can make the most of compound interest over the long term.
• Sometimes companies offer a discount share price to investors who commit to a DRIP plan.
• Access to fractional shares, which is useful if your platform doesn’t offer this feature.
• DRIPs often mean no extra commission charges or costs for buying more shares.
• By making a commitment, there’s less chance you’ll sell at the wrong time or make poor short-term decisions with your shares.

Are there any downsides or limitations with DRIP investing?

Like with any investing strategy, the DRIP method isn’t without its drawbacks:

• If you are retired or want to use your dividend income, a DRIP plan isn’t useful.
• You have less control over what you can do with your dividend payments.
• Reinvesting back into the same stock may not be the best investment decision.
• Sometimes DRIP programs have minimum requirements around the number of shares needed to qualify.
• Not all DRIP plans are the same, which can be confusing when dealing with lots of different companies.
• It only allows you to buy more of the same stock or fund.
• You’ll still need to think about how it impacts your tax position.
• This method can lead to an unbalanced portfolio if only some of your stocks pay dividends.
• You can always just reinvest dividends without having to commit to a fixed program.

How do you buy DRIP stocks?

Here’s a simple step-by-step guide to walk you through the process and explain what you need to do if you decide that a DRIP program suits your investing plans:

1. Choose DRIP stocks to invest in. Don’t just buy DRIP stocks or subscribe to a programme for the sake of it, make sure you actually want to own the underlying investments.
2. Pick an investment platform. You’ll need one that lets you subscribe to some form of dividend reinvestment plan (DRIP) with your stocks and shares.
3. Sign up and fund your account. You might need to wait for your account to be verified and for your funds to hit the account before you can begin using a DRIP strategy.
4. Find your chosen stock. You can search for its name or ticker, but you may have to contact a firm directly to sign up for a DRIP plan.
5. Review and buy. It’s as easy as that!

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What platform can I use to invest with this strategy?

It’s always worth double-checking with your investing platform before buying shares. But, at the time of writing, here are a few examples of brokerages that offer the ability to reinvest dividends with some investments:

• Interactive Investor
• AJ Bell
• Hargreaves Lansdown

Do you have to pay taxes if you reinvest dividends?

Yes, you still may have to pay tax on your dividend income. One way you can potentially avoid this tax burden is by using tax-efficient investment accounts such as a stocks and shares ISA or a SIPP (self-invested personal pension). For DRIP investments held within a tax wrapper, you may not have to pay tax on the dividend income generated and reinvested.

Expert analysis: Should everyone be using a DRIP plan?

Liz Edwards

Editor-in-chief

Not necessarily. There are plenty of useful benefits when you invest this way. But it's not for everyone.

For example, if your investing strategy focuses on growth instead of income, a dividend reinvestment plan may not be suitable. Investors looking for long-term capital growth with shares shouldn't head out and buy DRIP stocks for the sake of it.

A DRIP programme is sometimes recommended for investors saving for retirement. But, it's often overlooked that this kind of plan may not be suitable for an investor who is already retired or close to retiring. So, always keep in mind that DRIP plans are only useful if the underlying investments fit in with your overall investment goals.

Pros and cons of dividend reinvestment plans

Bottom line

A dividend reinvestment plan, or DRIP investing, is a useful strategy for income-focused investors who are still in the wealth accumulation stage. But, it’s not an investment program that’s designed to suit everyone. Also, not all stocks, shares, or funds offer this service. Many of the past benefits of DRIPs have become redundant in recent years because commission-free trading and buying fractional shares is now easier than ever.

Subscribing to a DRIP plan means making a commitment. It ensures your dividend reinvestments are efficient. But, it’s a system that still has flaws and won’t suit every type of modern investor.

FAQs

What does DRIP mean in investing?

This stands for a ‘dividend reinvestment plan’. It’s a way of using dividend income to automatically buy more shares in a particular stock or fund that you own.

Can DRIPs make you rich?

It’s definitely possible to build long-term wealth using a DRIP dividend reinvestment plan. But, it’s not a ‘get-rich-quick’ scheme because the power of compounding doesn’t happen overnight.

Is a DRIP taxed?

Yes, dividend payments that are going to be reinvested still qualify as a taxable event. However, you can potentially avoid paying some, or all of the tax on your dividends by holding your investments within a tax wrapper like a stocks and shares ISA or a SIPP (self-invested personal pension).

How do you qualify for DRIP?

If you’re buying shares directly from a company, you’ll need to notify them that you’d like to subscribe to a DRIP program. If you’re buying shares through your brokerage or investment platform, you can sometimes request to use a DRIP feature. This is done through your portfolio settings, or by speaking with customer service.

How many shares do you need for DRIPs?

This will depend on the company or the stocks you plan on buying. For some, there are no minimum requirements. But, certain stocks will have a minimum number of shares you need to hold to qualify for DRIP investing. So it’s always worth checking before you invest.