Was your grandfather on the assembly line at General Electric (NYSE: GE)? Did a dear friend live many more years thanks to a medicine made by Merck (NYSE: MRK)? If you have a sentimental attachment to a corporation that also meets your investment goals, a dividend reinvestment plan (DRIP) might be just the investment tool you’re looking for.
What is a Dividend Reinvestment Plan (DRIP)?
A public company issues stock, which is a fractional share of ownership in that company. When you buy a share of stock at a specific price, you hope the share price will go up because when you sell your share at a higher price than you bought it for, you make money.
Another way to make money as a stockholder is to buy a company that pays dividends on each share of stock. Not all companies pay dividends on their stock. Those that provide a dividend do so in part to show their confidence in the company’s worth and to attract investors.
A dividend is money a company regularly pays to its shareholders out of its profits or reserves. When you own stock in a company that pays dividends, you receive a cash payment each time dividends are distributed, which for most companies is quarterly. The company sets a rate per share of how much they will pay, and the company can increase, decrease or completely cancel that amount.
A way to buy stock directly from a dividend-paying company where you want to own shares is called a DRIP or direct stock purchase plan (DSPP), which is an investment service that lets you buy stock directly from the company.
For example, in 2021, PNC Financial Services Group (NYSE: PNC) pays a dividend of $4.60 per share a year or $1.15 per share quarterly for each share you own. That means if you own 100 shares of PNC, you would be paid $115 that quarter ($1.15 times 100 shares) and each quarter after that.
You would continue to receive that cash payment each quarter for as long as you own the shares and as long as PNC chooses to continue to pay that dividend. Instead of depositing the money into your bank, you could set up a DRIP where each of those quarterly dividend payments would buy you more shares of PNC.
Pros and Cons of DRIPs
- Risk of not being diversified enough by owning too much of one stock
- If you also work for the company, may be too many eggs in one basket
- Can only buy and sell at market price
How Does a DRIP Work?
In this reinvestment plan, you choose to have the cash dividends paid by the company automatically reinvested into additional shares of company stock. If you set up a DRIP, the process becomes automated and usually requires minimal monitoring. In that case, instead of getting a dividend paid to your bank account, the company would use the money to purchase shares or partial shares of the stock.
With a DRIP, over time you would own more and more shares of the stock. Your new shares would be purchased at the stock price at the time of purchase, which varies. Some of the shares you own would be bought at higher prices and others at lower prices, which would average out your total share cost over time.
An example of a DRIP would be a plan offered by a company like PNC Financial Services (PNC). If you signed up for that plan on the PNC website, each quarter when a dividend is paid, your share of the dividend ($115 from our example above) would be used to buy more PNC stock instead of being paid to you. No transaction fees are charged in this transaction. You can stop a DRIP plan at any time.
If you feel confident that a particular company is going to continue to do well and you want to be part of that anticipated growth, you could participate in that company’s DRIP. As with all investments, you want to regularly evaluate the strength of the company and the place it holds in your portfolio.
With DRIPs at certain companies, you could buy as little as $25 worth of stock at a time without paying money or fees to buy that stock. Some companies have DRIPs they administer themselves. In that case, go to the investor relations section of the company website and follow the instructions. The company may or may not charge a fee to buy stock.
One example of this stock purchase plan service is from the Kellogg Co. (NYSE: K). You can get more info about its DRIP on the company’s investor relations website.
Other companies allow you to buy stock directly from them through what’s called a transfer agent. An example of a transfer agent that many companies use is Computershare. Go to Computershare’s website and you’ll see “Buy Stock Direct.”
There you’ll find a list of all the companies for which Computershare is the transfer agent, the stock symbols, the minimum amount to invest and how to accomplish purchases. If you want to buy stock in a particular company, check the investor relations section of its website to find out whether it runs its own DRIP or who the transfer agent is.
Reinvest Dividend Options
Investors can usually enroll in an automatic dividend reinvestment program through their brokerage accounts. They should be able to find this feature in their Account Settings menu.
Once it is selected, investors usually have the following options: The brokerage may require a market price bottom for stocks that can be set up as a DRIP; the stock must be one that offers dividends. The brokerage house will probably have you complete a special DRIP enrollment form.
Remember that in a DRIP, your dividends buy at market price; you can’t set specified buy prices like a limit order. Although you can buy fractional shares through a DRIP, when you sell later, that one fractional share you have left will be exchanged for cash by your broker rather than sold.
DRIP Investing and Taxes
Stocks that pay dividends can be a valuable part of your investment portfolio. When you buy stock, you take a risk that the stock may decline in price, causing you to lose some or all your principal — the amount you used to buy the stock. Companies that pay dividends on their stock can still lose value, go out of business or stop paying dividends, but during the time you own the stock, you will earn every dividend the company pays out.
You do pay income taxes on dividends earned each year even when you directly reinvest the dividends you earn from a stock. If you earn $60 per quarter in dividends from a stock, you will get a 1099-DIV that shows $240 in qualified dividends ($60 in dividends times 4 quarters in a year) that you would add into your other W-2, 1099 and stock-sale income for that year. Dividend income is subject to different tax rates than other types of income.
DRIP vs Online Brokerage
You can participate in a DRIP directly through a company you want to own stock in. Go to the company website and look for the link for investor relations. It is usually at the bottom of the page.
Or you can use your online brokerage account to set up your own personal DRIP for any dividend-paying stock you fancy. Any of the individual brokerage houses you choose offer the ability to set up periodic purchases of a stock you want to buy and a way to send the dividends of a particular stock directly into a purchase of that same stock. Additionally, with your online broker account, you can set up DRIPs for exchange-traded funds (ETFs) that offer dividends.
When Ease Meets Wisdom
Magic is in short supply these days, but a successful DRIP is one of the closest ways to get some pixie dust to land on you. When it works out, you may see that several years after you start a DRIP, your initial investment has grown much more than it might have had you actively traded other stocks. DRIPs shouldn’t make up the whole of a sensible investment portfolio, but they can be a valuable part of one.
Frequently Asked Questions
Are DRIP plans worth it?
Yes, a DRIP plan can be a worthwhile part of your investment portfolio. DRIPs allow you to keep investing in a company or a group of companies via an ETF that you consider to be headed in the right financial direction. Once set up, DRIPs require no attention beyond periodically evaluating the wisdom of continuing in that investment.
How do you calculate drip dividends?
To figure out DRIP dividends and compare dividend yields among stocks, divide the annual dividend by the stock price. From our examples above, PNC’s annual dividend is $4.60; Kellogg’s annual dividend is $2.28. Stock prices change, but at this moment with PNC’s price at $177.41 and Kellogg’s price at $63.34, their dividend yields are 2.59% and 3.6 %, respectively.