A great deal of focus has been placed on dividend investing lately, and for good reason: Dividend stocks (especially dividend aristocrats) often have solid fundamentals, and can usually weather stock market downturns. On top of that, you receive regular income from dividend stocks.
Stocks that pay dividends are paying out portions of their profits to shareholders. This money is paid out monthly, quarterly, semi-annually, or annually, and is paid out regardless of share price. You can use dividend income for whatever you want; it’s yours and can’t be taken back.
One aspect of dividend investing is taking part in a DRIP – a Dividend Re-Invesment Plan. Let’s explore what DRIP investing is and how it can grow your wealth.
What is a DRIP?
While some people use dividend income to pay bills, or for other purposes, others prefer to reinvest their dividends. When you reinvest your dividends, you buy more shares of the company with your dividend income. Because your dividend payout partially depends on how many shares you own, reinvesting can boost the number of shares you have, in turn boosting your dividend payout.
But it’s not very efficient to take your dividends and go buy additional shares. Enter DRIPs.
A DRIP program is offered by the company of the stock you own. (Not all companies offer DRIPs.) Through the company you have the option of reinvesting your dividends rather than receiving a dividend payout. Through a DRIP, an investor is able to buy partial shares with their dividend without having to pay a broker fee (though some DRIP plans do have some fees involved).
Notice that cute play on the word DRIP? See, what you are doing is building up your stock in a company one drop at a time through the reinvestment of your dividends.
In order to take part in a company’s DRIP you have to own a share of their stock in your name. This means you are actually listed on the stock certificate (though many days the certificate is in record only as the actual stock is held online).
When you buy a stock through a broker, the broker is usually listed. You can have a broker issue you a share in your name to get your one share (this will involve a fee).
You can also go through a company such as firstshare.com, which will connect you with a shareholder who will sell you a share to keep in your name.
Some companies offer you the opportunity to buy your first share directly through the company via a Direct Stock (or Share) Purchase Plan/DSPP.
There’s Another Way to DRIP
These days you don’t need a traditional DRIP in order to take advantage of reinvesting your dividends. Many investment brokers will reinvest your dividends for you, if you choose that option. (Take a look at some of the best online discount brokers, where you can find the dividend reinvestment option). This have been called a “synthetic DRIP.”
Let’s Look at a DRIP Example
If you own 100 shares of KO (Coca-Cola), and Coke pays a quarterly dividend of $0.47 per share, you would get $47 every three months. With a dividend reinvestment plan, that money would automatically be used to buy more shares of KO. If the price is $67.85, you will be able to buy 1.44 shares. Now, you own 101.44 shares of KO. Next quarter, your new dividend payout will be $47.68.
That extra $0.68 might not seem like a lot, but remember that you will continue to build the number of shares you have in KO. And it’s worth remembering that KO is a dividend aristocrat — meaning that every year for at least 25 years, the company has raised its dividend.
The idea behind DRIP investing is that you gradually build up your portfolio, using what many consider “free” money to acquire more shares at virtually no cost to you.
You can see how much potential KO has by using a dividend reinvestment calculator. Using current information on KO, including the current dividend payout, the current yield of 2.77%, an estimated dividend growth rate of 7.2%, and an estimated stock price growth rate of 6%, in 20 years the total value would be $41,747.22, and you would own 191.85 shares. That’s not bad when you consider that you started out with 100 shares at a value of $6,785, and all you did was reinvest your dividends. Even with less optimistic numbers, say a dividend growth rate of 5% and a stock price growth rate of 3%, you would still end up with a total value of $24,441.77.
Building a Dividend Portfolio
You don’t have to just buy 100 shares of a stock and let it go at that. Instead, many DRIP investors use dollar cost averaging to build their portfolios. They invest in dividend stocks from different sectors, and even from different countries. It is even possible to invest in funds that pay dividends to get instant diversity, if you want to go that route.
With dollar cost averaging, you can buy partial shares, and start building your portfolio slowly. Over a period of years, as you consistently add to your holdings, and as DRIPs boost your investment even more, you can build wealth. Indeed, in some cases, it is even possible to build your dividend portfolio to the point that you can stop using the DRIP, receiving your dividends and living off them.
As you can see, a DRIP, either directly through the company stock or through a brokerage, is a great way to compound the amount of stock you own. Over time, reinvesting your dividends for more stock shares can grow your wealth incredibly. Make sure you understand any fees involved before taking part of a plan. Also understand that you need to keep good records of the purchases so you know the cost basis of the shares should you sell them later on.