DRIP is one acronym in an investment world overloaded with acronyms. It may conjure strange images upon first hearing it. But a DRIP (or DRP) has nothing to do with a leaky faucet.

For investors, a DRIP is a Dividend Reinvestment Plan. And DRIPs are fantastically effective and simple to start – you don’t need a lot of money to get going with one. A DRIP is simply the automatic reinvestment of a stock’s dividend.

dripsMany companies offer DRIPs that you can invest in directly with the corporation whose stock you want to own. In some cases the purchase of a single share of stock may be sufficient to set up an account. Once you’ve done so, every time a dividend is paid, it is automatically reinvested into more shares of the company’s stock. The DRIP buys the shareowner as many whole and fractional shares equal to the dollar value of the dividend.

Many years ago it was more common to go this route, setting up a DRIP directly with a corporation. Back then, brokerage firms offered dividend reinvestment but charged a commission for each reinvestment transaction. For people looking to start out with only a few shares of stock the commission was sometimes greater than the dollar value of the dividend.

Fortunately, these days many brokerage firms will reinvest your dividends at no cost to you. But whether you are just starting out, or are wealthy and in possession of a sizable portfolio, participating in a DRIP with your stocks can prove extremely valuable.

Understanding DRIPs

When you make regular investments in stocks you are performing a process known as dollar cost averaging. This means that you are buying additional shares regularly, averaging the cost per share, and thereby reducing the concern many investors have over when the right time to buy a stock might be.

Some DRIPs that are offered directly with a corporation also offer discounts on the price of stock. A typical discount of between 1% and 10% means that, for the shares purchased through the DRIP, the investor has an immediate profit.

DRIPS provide benefits for the corporation too. Direct DRIPs give a corporation another way to raise capital. When you buy shares on the open market you are buying from another shareholder. But when you participate in a DRIP you are buying directly from the company, giving it new money in exchange for shares.

DRIPs also create shareholder loyalty. One of the primary tenets of a publicly traded company is to increase shareholder value. Providing a DRIP is one way to motivate shareholders to not sell shares which is helpful in maintaining, and increasing, the share price.

Not all companies offer DRIPs, but it is easy enough to find out if one does. Simply go to the company website and click on the Investor Relations tab. If a DRIP is available, you’ll find it there.  And even if the company doesn’t offer a DRIP, but does pay a dividend, your brokerage firm may offer the service free of charge. The bottom line is this: whether sponsored by a corporation or provided by your brokerage firm, dividend reinvestment plans are a great way to systematically grow your wealth.

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