Many companies which pay dividends on their stock also offer dividend reinvestment plans, or DRIPs. Receiving a quarterly dividend check is nice, of course, but you’re probably not going to be receiving much at once, and many of us would be inclined to fritter that extra cash away. DRIPs help you make more effective use of those dividends, automatically reinvesting them in the company — slowly raising the value of the stock, and making each successive dividend just a little bit bigger. DRIPs allow investors to buy stock in small quantities and even fractions of shares so the entire dividend is reinvested.
Of course, you’re making a long-term investment, so you want to feel as confident as possible in the company in question. Moreover, you don’t want to commit all your savings to just one company — if you expect to lean heavily on your investments in the future, diversifying your DRIP portfolio across multiple sectors is essential.
So DRIPs present an excellent opportunity for those who wish to slowly grow their stake in a given company, perhaps from a relatively small initial investment.
How do you get started in DRIPs?
While DRIP rules differ from company to company, many only require you to own a single share, and some companies allow you to buy that share directly through the DRIP, avoiding brokerage commissions and fees . If working without a middleman appeals to you, research companies to see if they have a Direct Stock Purchase Plan. DRIPs are popular forms of investment for small investors because of the low minimum investments available and the lack of brokerage fees. If you are only investing $25 at a time even a $5 fee is a large portion of your investment. DRIPs also allow investors to effectively take advantage of dollar-cost averaging.Dollar cost averaging (DCA) is an investment strategy that involves investing equal amounts of money on a regular basis (such as $25 a week). By doing so, you buy more shares when prices are low and fewer shares when prices are high. The result is a lower average cost per share, giving the investor a lower overall cost for the shares in the long run.
If you take this option, you’ll need to take care to keep records of each investment — both the first and later automatic investments — in order to accurately pay capital gains tax if or when you eventually sell some of the stock.
Alternately, you can reinvest dividends — often for free — through a brokerage. You’ll get hit with commissions and fees, but this option allows you to make automatic reinvestments in companies that don’t offer their own formal DRIPs. Moreover, if you’re building a portfolio, you’ll keep all your information in one place, which will make things a lot easier when it comes time to sell.
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