Miranda Marquit has been covering personal finance, investing and business topics for almost 15 years. She has contributed to numerous outlets, including NPR, Marketwatch, U.S. News & World Report and HuffPost. Miranda is completing her MBA and l.
Miranda Marquit ContributorMiranda Marquit has been covering personal finance, investing and business topics for almost 15 years. She has contributed to numerous outlets, including NPR, Marketwatch, U.S. News & World Report and HuffPost. Miranda is completing her MBA and l.
Written By Miranda Marquit ContributorMiranda Marquit has been covering personal finance, investing and business topics for almost 15 years. She has contributed to numerous outlets, including NPR, Marketwatch, U.S. News & World Report and HuffPost. Miranda is completing her MBA and l.
Miranda Marquit ContributorMiranda Marquit has been covering personal finance, investing and business topics for almost 15 years. She has contributed to numerous outlets, including NPR, Marketwatch, U.S. News & World Report and HuffPost. Miranda is completing her MBA and l.
Contributor Michael Adams Investing EditorMichael Adams is an investing editor. He's researched, written about and practiced investing for nearly two decades. As a writer, Michael has covered everything from stocks to cryptocurrency and ETFs for many of the world's major financial publicatio.
Michael Adams Investing EditorMichael Adams is an investing editor. He's researched, written about and practiced investing for nearly two decades. As a writer, Michael has covered everything from stocks to cryptocurrency and ETFs for many of the world's major financial publicatio.
Michael Adams Investing EditorMichael Adams is an investing editor. He's researched, written about and practiced investing for nearly two decades. As a writer, Michael has covered everything from stocks to cryptocurrency and ETFs for many of the world's major financial publicatio.
Michael Adams Investing EditorMichael Adams is an investing editor. He's researched, written about and practiced investing for nearly two decades. As a writer, Michael has covered everything from stocks to cryptocurrency and ETFs for many of the world's major financial publicatio.
Updated: Aug 9, 2023, 12:59pm
Editorial Note: We earn a commission from partner links on Forbes Advisor. Commissions do not affect our editors' opinions or evaluations.
With a dividend reinvestment plan (DRIP), you buy shares of stock in a company with the dividend payments from that same company. Investors who opt into a DRIP take advantage of dollar-cost averaging, compounding returns and potential discounts on stock purchases to help maximize the value of their dividend investing strategy.
Dividend investing is a popular strategy for generating income and saving for retirement. When you buy dividend stocks, the companies you own pay you a portion of their earnings as dividends based on the number of shares you own. Dividends provide cash flow from your stock investments without requiring you to sell any shares.
Investors can save their dividends, invest them or spend them as regular income. A dividend reinvestment plan automatically purchases more shares of a company’s stock with the dividends they pay out, whether that’s each month, quarter or year.
Not all public companies that pay dividends offer a DRIP. However, if a company you invest in doesn’t offer a DRIP, your brokerage may still enable you to automatically reinvest dividends.
For beginners hoping to grow their portfolios faster through compounding returns, DRIP investing can make a lot of sense. It essentially provides you with free shares that entitle you to more dividends which you can use to buy even more shares. Then you’re even better poised to benefit from any increases in stock price. Remember: A large percentage of the S&P 500’s long-term returns have been from reinvested dividends.
However, if you’re already past the growth phase of your portfolio and you’re planning to live off your dividend income, it might make sense to stop with the DRIPs and start using the income your dividends generate for everyday expenses.
Consider speaking with a financial or investment professional about your situation and goals to put together a portfolio strategy that works for you.
DRIPs help you take advantage of dollar-cost averaging. With a dividend reinvestment plan, you buy shares of stock at regular intervals, which may lower the average price you pay per share over time. In addition, you may be eligible to pay less per share through some DRIP plans that discount the current market share price for investors who reinvest their dividends.
Dividend reinvestment plans are also an excellent way to generate compound returns. Investment returns compound over time, and reinvested dividends provide you with even more compound growth. According to an analysis from Hartford Funds, 78% of S&P 500 returns going back to 1978 can be attributed to dividend reinvestment and their resulting compound returns.
Here’s how this plays out: Let’s say you invested $10,000 in PepsiCo (PEP) in October 2010 and reinvested all your dividend payments for a decade. Your initial investment would have bought 153.82 shares of PepsiCo. After a decade of dividend reinvestment, you would own 206.54 shares worth more than $28,800. That’s an increase in over 50 shares and almost $19,000 without using any more of your money to buy new shares.
In the past, DRIPs offered a couple of other advantages that have become less relevant over time. DRIPs often charged zero commissions at a time when commissions ran high for stock purchases. They also gave investors access to fractional shares, which allow investors to purchase shares in dollar amounts too small for a full share. Today, many brokerages charge zero commissions on stock trading and offer fractional shares of many leading stocks as well, diminishing these DRIP advantages.
There are a number of places to find DRIP stocks for your portfolio. You might start with the dividend aristocrats, a list of companies that have a long history of raising their dividends each year. To be considered a dividend aristocrat, a company must have increased its payout annually for 25 consecutive years.
Of course, not all stocks can be aristocrats, but there are plenty of companies that still pay regular, reliable dividends. As you research companies, look at their dividend histories to determine whether they’ve been paying them consistently over time—even if they haven’t increased the payout.
Once you’ve determined which companies you want to invest in, you have a few options for DRIPs:
A dividend is considered taxable income, and even if you directly reinvest your dividends without seeing them in your account first, they’re still reported to the IRS as income.
Dividend income is listed on Form 1099-DIV as either non-qualified or qualified. You should receive this form from your brokerage or direct stock purchase provider. Non-qualified dividends are taxed at your ordinary income rate while qualified dividends, which most dividends from U.S.-based stocks and funds are, get favorable tax treatment similar to long-term capital gains taxes.
It’s important to note that dividends from real estate investment trusts (REITs), employee stock options or master limited partnerships (MLPs) are not qualified dividends.
