Many companies pay out dividends to their stockholders. If you own stock in a company that pays dividends, you can receive those dividends as cash, or you can choose to
Many companies pay out dividends to their stockholders. If you own stock in a company that pays dividends, you can receive those dividends as cash, or you can choose to have those dividends reinvested. That is, you can use those payments to buy more company stock.
The potential benefit of this approach is clear when you look at the stock market's historical returns with and without dividend reinvestment: The S&P 500's average return from 1928 through 2017 was about 7.6%, but if all dividends had been reinvested, it would have been about 11.5%, according to NerdWallet's analysis of data posted online by Aswath Damodaran, a finance professor at New York University's Stern School of Business.
There are two main ways to set up a dividend reinvestment plan:If you invest through a brokerage account, many brokers will let you choose to reinvest your dividends, rather than receive them as payouts.You can invest directly in the dividend reinvestment plan, or DRIP, offered by the company you want to invest in, assuming it has one. You don't need a brokerage account.Company DRIPs vs. brokerage-based dividend reinvestments
Company DRIPs have substantially different features than brokerage account reinvestment plans. Almost 900 companies that trade on U.S. exchanges offer DRIPs, says Chuck Carlson, a chartered financial analyst and editor of DRIP Investor, a newsletter on dividend reinvestment topics, including details about company plans.
When choosing between the two approaches, keep in mind that company DRIP plans are solely for people who want to invest in individual stocks " and specific stocks, at that. If you want the easy diversification of a mutual fund (a single investment that invests in many companies on your behalf), then go with a brokerage account. We reviewed the best brokers for mutual funds.
Also, if you just want to reinvest dividends, it may be simpler through a brokerage account, which offers consolidated investment statements and a one-stop-shop for investing.
While company DRIPs have other advantages, you'll need to track down the details of each company's plan. Once enrolled, you'll likely receive a separate statement for each DRIP you're invested in.
But here's when company DRIPs can make sense: if you don't have much money, but you want to get started investing in an individual company. The main value of a DRIP, Carlson says, is that in addition to reinvesting their dividends, investors generally can send in money to purchase fractional shares " $50, say, will buy a piece of a $130 stock.
That's because most company DRIPs offer 'optional cash investments' on a fractional-share basis, Carlson says. Once you're enrolled in the DRIP, he says, 'You can send money directly to the company " a check or automatic debit or whatever " and you can buy additional shares.'
The best part? The minimum investment amount tends to be small, such as $10 to $50, even if the share price is higher than that.
'It's a door-opener for people who think they're kind of shut out because they don't have a lot of money to invest,' Carlson says.
While brokers are likely to offer dividend reinvestment plans (through which fractional shares may be purchased), they're less likely to let you purchase a stock outright for less than the full share price. That said, some investment apps offer that feature. For example, Motif and Stash let you buy individual stocks via fractional shares.The benefits of company DRIPsIn addition to purchasing stock by reinvesting your dividends, companies that offer DRIPs often will let you buy additional stock on a fractional basisIn DRIPs, companies sometimes offer their stock at a discount to the market price (in some cases, the discount is available only on the shares purchased through dividend reinvestment, not the optional cash purchases)Depending on the specific plan's fees, investing in a DRIP may be cheaper than purchasing through a broker. Some DRIPs don't charge commissions or fees to enroll or to buy shares; others charge enrollment and other fees, but they may add up to less than broker trading costs.Some company DRIPs let you invest through your IRA. (See if automatically reinvesting your IRA dividends makes sense for you.)The downsides of company DRIPsThe companies follow their own schedules for investing your money " it may be days between the time the company receives your 'buy' request and the time it invests your money, and the same goes for selling shares. This can be a good way to avoid panic selling, but it's not for everyone.To enroll in a DRIP, some, but not all, companies require that you're already a shareholder. One solution is to buy a single share from a broker and then ask the broker to register that share in your name (the broker likely will charge a fee for this service).There's usually a fee to sell shares. It's not unusual to see a flat fee of $5 to $15, plus a per-share sale fee of 5 to 12 cents, Carlson says.There may be enrollment and other fees. DRIP fees and terms vary, so you'll need to do your research to find the best plans (and, of course, make sure the company is a worthwhile investment).Managing multiple company DRIPs may entail more paperwork than holding a single brokerage account. And it's important to keep your records straight, because generally you owe tax on dividends in the year you received them, even if those dividends were immediately reinvested.
If you're interested in exploring the details of some company DRIPs, visit the stock purchase page of Computershare, a company that acts as a transfer agent for many DRIPs.Keep it simple with a brokerage account
If the company model seems too onerous, you might want to stick with setting up dividend reinvestment with a discount brokerage, where you can access multiple investment types " individual stocks, mutual funds and exchange-traded funds, or ETFs, to name a few " from the convenience of one account.
'For most people, it's easier to do that because you just have one account and you don't have to worry about more paperwork and more accounts to keep track of,' says Charles Rotblut, vice president of the American Association of Individual Investors, a nonprofit group that aims to educate investors.
However you do it, reinvesting dividends can be a powerful way to boost your returns over the long term.
'You're taking the cash that's distributed to you and you're putting it right back to work,' Rotblut says. 'Say you get enough dividends to buy one additional share of stock. That additional share of stock gives you more total dividend dollars and it just keeps growing.'
That said, keep an eye on any investment in which you're reinvesting dividends continuously over time, says Benjamin H. Dorsey, a certified financial planner and partner at Court Place Advisors in Ellicott City, Maryland. You want to make sure you don't become over-concentrated in that position, he says.
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Andrea Coombes is a writer at NerdWallet. Email: email@example.com. Twitter: @andreacoombes.