It's been awhile since I did a Series 101 post. Let's get back to the basics. Today we are going to address DRiPs. What is it and should you care? Read on to find out.
What is a DRiP?
DRiP stands for "Dividend Reinvestment Plan". When a company makes a profit, there are several different ways to deal with this money:
- Sit on it - Yep, a company can simply decide not to spend that profit. Remember this news story way back from 2011? Apple now has more cash than the U.S. government.
- Reinvest it into the business - If it seems like there is a Starbucks on every street corner, it's because there is a conscious effort to make it so by Howard Schultz & Co. A company can decide to use profits toward expanding their current business, developing new products & services or sometimes make seemingly inexplicable acquisitions - see Mars buys VCA veterinary chain.
- Reward the employees - Had a record sales year? Well you reasonable should expect a little extra in that year-end bonus check. Pretty straightforward.
- Reward the shareholders - This is where the dividend comes in. A dividend is simply a "Thank You" from the company to its shareholders. It may take the form of cash, shares of stock or other property.
When a dividend is issued, it commonly come in the form of cash. For example, Apple (AAPL) currently has a dividend yield of 2.1% - which means Apple pays an annual dividend worth ~2.1% of the stock price. But as you may have realized, unless you have a lot of money invested, dividend payments will lead to small amounts of cash showing up in your portfolio. Normally these small amounts of cash will get sent to you in the form of a check or direct deposit. But what if you would rather reinvest that money right back into the company? This is where the DRiP comes in.
- A DRiP plan will automatically reinvest your dividends to purchase more shares (even partial shares) of a company's stock WITHOUT commission.
- Shares purchased via a DRiP may be discounted from the share price you would pay when buying on the open market.
- The BIGGEST benefit - long term potential of compounded earnings. See "Eighth Wonder of the World".
- Compound interest can go both ways. If you happen to buy into a poorly performing company, then you may be better off keeping those dividend dollars rather than reinvesting it into a losing operation.
- Some DRiP plans may come with fees. Review the terms carefully before you sign up.
DRiPs offer an automated way to reinvest your dividend payments without fees or commissions. I have DRiP enabled on all of my investments. If the potential of compounded losses keeps you up at night, then you should reconsider whether you should continue to be a shareholder in the company.
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