What is a DRIP?

A Dividend Reinvestment Plans (DRIP) is a plan offered by public corporation that allows individuals to reinvest dividends and make cash purchases of stock directly from the company. Instead of the corporation paying out its regular dividend in the form of cash to its shareholders, the proceeds are used to purchase additional shares or fractional shares of the company.

A DRIP is an excellent way to increase the value of your investment. Most DRIPs allow you to buy shares commission free and sometimes at a discount to the current share price.

There are currently over 1,000 publicly traded corporations that offer DRIPs. The specifics of the DRIP plans vary as widely as the corporations themselves. For example, some corporations allow investors to make contributions as often as every week. While others only allow stock purchases to be made on a quarterly basis.

What benefit does the Company get?

Corporations that offer Drips are more than willing to aide individual investors in getting started because it offers the companies low-cost access to capital. The capital, which is attained by corporations, through DRIPs, is then reinvested into the company itself in order to grow future earnings.

It's a mutually beneficial relationship between the investor and corporation and provides the company with a stable shareholder base who typically has long-term investment characteristics, thus less likelihood of volatile price swings. Moreover, the steady flow of capital into DRIP plans helps to stabilize the normal market fluctuations that are associated with any publicly traded company.

Benefits of DRIPs:

There are several benefits to participating in DRIPs. The first benefit of a DRIP is that the plans generally require very small initial investments. Individuals can begin investing with as little as $10 in some of the world's most well-known and respected companies, including IBM, Coca-Cola, AT&T and McDonald's, just to name a few.

Many savvy and wealthy individuals use DRIPs as a means of accumulating large blocks of stock and building their own well-rounded, diversified portfolios in growing, well-managed companies.

The second attractive attribute to DRIPs is their low cost and lack of commissions. In bypassing the broker and its costly commissions, and buying stock directly from companies, investors lower their costs of investing, which allows for greater profits over time.

Another benefit of DRIPs is the fact that most investors will dollar-cost-average, or invest a fixed dollar amount on a regular basis into the plans. The benefit of such a strategy is that it removes much of the emotion that is involved with investing and managing one's own money, which is a detriment to most.

Types of DRIPs:

Company-run: Many companies take it upon themselves to run their own Drips. These very often are the companies that allow you to buy directly through them without you having to even own a single share, although this is not always the case. The company-run Drips are simply administered from corporate headquarters, normally as part of the overall shareholder relation’s effort.

Transfer agent-run: As management of Drips has become more cumbersome, many companies have turned to third-parties called "transfer agents" as a way to make things simpler for themselves. Transfer agents are financial institutions that basically run DRIP programs for a number of companies. Because they can do this for a lot of companies, they can often use the same resources for a number of customers and provide the entire plan at a much better rate than the company could do so by itself.

Brokerage-run: Some brokerages will allow shareholders to reinvest dividends at no cost, even if the company in question does not have a formal Drip plan itself. However, these brokerage-run plans strictly pertain to dividends only and do not allow any optional cash purchases like an Optional Cash Purchase Plan (OCP) would, and optional cash purchases are a big part of what makes Drip plans so attractive.

Taxation:

Another misconception about DRIPs is that they are not subject to tax because the investor is not receiving a cash dividend. In fact, while DRIPs are beneficial for their cost-effective approach to investing, they are still subject to tax. Because there was an actual cash dividend, although reinvested, it is considered to be income and thus taxable. And, as with any stock, capital gains from shares held in a DRIP are not calculated and taxed until the stock is finally sold, usually several years down the road.