What Is a Dividend Reinvestment Plan (DRIP)?

What Is a Dividend Reinvestment Plan (DRIP)?

A dividend reinvestment plan (DRIP) is a dividend investing method that reinvests cash dividends into additional (or fractional) shares of an underlying stock.

In the past, this term has applied to the publicly traded companies and funds that offer DRIP programs.

Today, however, the fintech boom (financial technology) and subsequent arms race between different investing platforms means that many investors have access to automated reinvestment programs offered by their brokerage of choice, irrespective of which underlying stock they own.

How Do DRIP Programs Work?

Cash dividends are normally paid to investors in the form of a deposit into their brokerage account or a direct deposit into their bank account.

A dividend reinvestment plan instead uses an investor's dividend payout to purchase additional shares of the underlying stock.

In the past, this was particularly valuable to long-term investors. The dividend reinvestment was traditionally handled by the company that issued the stock, meaning that there were no commissions to be paid to brokerages for what amounted to additional shares of the company.

Additionally, as additional shares are purchases, the position size of the investment grows passively over time. By purchasing shares when the share price dipped, investors were essentially “buying” the stream of dividends at a discounted price.

One drawback to this system for investors is that the shares included in the DRIP program are issued and managed directly by the company that issued the underlying stock.

This generally means that the shares are not available on the open market and are therefore less liquid.

Dividend reinvestment plans are beneficial for the companies that issue them as well.

Shareholders are more likely to hang on to their shares even if the price sinks. Enticed by the DRIP benefits, investors generally have a longer time horizon in mind and are therefore willing to wait out rocky market conditions.

Dividend Reinvestment Plans Today

For decades, fractional shares were seen as an inconvenience.

Today, fintech-enabled brokerages are building their entire business models around fractional shares in an effort to reach new, younger investors. Platforms such as Acorns, Stash, and Robinhood have wholeheartedly embraced investing with fractional shares.

Robinhood—the commission-free investing pioneers—are taking it a step further with the addition of a comprehensive dividend reinvestment plan offering on their platform.

Fintech investing newcomers aren’t the only ones bringing DRIP benefits to their customers; investing mainstay TD Ameritrade offers a similar program.

Using these tools, investors can automatically reinvest the dividends from any stock that pays dividends instead of just those with their own DRIP programs. The benefit is compounded as more and more platforms abolish commissions, meaning dividend reinvestment plans are more accessible and less expensive than ever before.

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