Dividend reinvestment plans, or DRIPs, are investment strategies that make it easier to utilize the dividends generated by various holdings to purchase additional shares of those same holdings. In many cases, a DRIP investing approach calls for establishing a mechanism that automatically allows all or a portion of dividends received from selected shares of stock to be used as the funds for purchasing more shares of those same stock options. With this approach, investors can incrementally increase their holdings in a particular stock holding, which in turn yields additional dividends over time.
In actual practice, DRIPs work by circumventing the need to actually issue a dividend payment to the stockholder. Instead, the investor receives notification of the total dividend earned for the period, then a breakdown of the number of shares that have been purchased with that dividend. It is not unusual for the issuing company to cover any broker’s fees associated with the transaction, and also to price the shares at a slight discount.
Both investors and companies can benefit from the use of DRIPs. For investors, the ability to acquire additional shares is more or less automatic, making it possible to avoid the hassle of submitting an order to a broker in order to acquire additional shares. At the same time, the investor is able to acquire those additional shares at a unit price that is less than the current market price. The end result is the ability to build a profitable portfolio for less money and effort, a strategy that is often considered a great way to manage long-term investment options.
Companies also benefit from the DRIPs approach. The ability to sell additional shares to investors instead of issuing dividends effectively helps the business raise additional capital for use in expanding the business operation. In addition, the company saves on the expenses normally related to mounting some type of public offering, since the current investors are acquiring available shares through the DRIPs program.
One potential liability of a DRIPs strategy is that, should the shares issued by the business begin to falter in the marketplace, the investor may do well to receive the dividends and begin selling off his or her shares before the stock price reaches a certain low level. Depending on how the DRIPs approach is structured, there may be a waiting period before those recently acquired shares can be offered for sale. For this reason, reading the terms and conditions associated with the DRIPs offering before committing to this strategy is extremely important.