Dividend reinvestment plans (DRIPs) allow for the automatic reinvestment of stock or mutual fund dividends for the purpose of gaining more shares.
DRIPs are actually a form of dollar costaveraging—a strategy of depositing equal amounts of money into a stock or mutual fund at regular intervals, resulting in the purchase of more shares when prices are down and fewer shares when prices are up.
While dollar cost averaging doesn’t guarantee a profit—or remove the risk of loss—this technique does offer an investor the potential to substantially increase holdings over time. For example, for each share of a stock or a mutual fund paying a 10% dividend, an investor would have 2.59 shares over ten years.
Covering the Bases
When investigating DRIPs, keep in mind that plans differ in several important respects. Consider asking the following questions:
- What is the performance history of the issuing company? Potential investors should always examine the prospectus.
- How many shares must be purchased? Some plans require that investors buy a specific number of shares before they may participate.
- Are there any reinvestment fees? Many companies do not impose fees, while others may charge for each transaction.
- Can additional shares be purchased for cash? Some plans allow investors to take further advantage of dollar cost averaging by investing an additional amount each month with little or no commission.
If you are looking for an automatic investment program with low expenses and the potential for long-term accumulation, a DRIP could be a solid option worth considering.