What is a Dividend Reinvestment Plan (DRIP)? Pros and Cons

Dividend Reinvestment Plan
Dividend Reinvestment Plan

The stock market is characterized by volatility, and every investor will have crucial questions such as, “Where should I invest?” How should one invest? how much should be invested?

When an investor gets a lump sum of money, he or she must decide whether to invest the money all at once or through a monthly investment plan. In this case, both options have advantages and disadvantages, and the final investment decision is up to the investor. The investor will analyze the risk, the quantity of capital to dispose of, and market changes.

By investing a big sum in the stock market, you may put all of your money to work. If you have made plans to invest tiny sums of money, you will earn interest on the funds you have invested. A dividend reinvestment plan, often known as Drips, is a method by which cash dividends from assets are automatically reinvested in stock. Enrolling in drip investment facilitates the reinvestment of cash dividends and is sometimes cost-effective.

What is Drip Investment?

Drip investments are systems that invest any cash dividends you get on your assets in shares automatically. It is necessary to enroll in a drip in order to utilize the service, however this technique is not required.

Brokers will supply you with investing opportunities. The drip investment of stocks, for instance, may be made through mutual funds, American depository receipts, ETFs, and other vehicles.

How does it work?

Consider that you own 500 shares of a corporation that pays a dividend of 1 AED per share. A broker assisted you in enrolling in a drip program. When the corporation distributes dividends, you will receive 500 AED.

If you have received the dividend and the stock is currently trading for AED25 per share, you will receive 20 more shares of stock instead of AED500 in cash.

Drip Investment Pros and Cons

The following are the pros and cons of drip investment.

Pros

  1. Averaging
  2. Reinvestments
  3. Low commission

1. Averaging

Automatic dividend investment will result in dollar-cost averaging. The technique of dollar-cost averaging entails recurrent investment purchases. Not a one-time investment purchase. When you purchase more shares at more frequent periods, the total average purchase price will decrease.

2. Reinvestments

Dividends are automatically reinvested into shares, while drips lessen the likelihood that dividends will remain in your account. If the available dividends in your account remain uninvested and you must invest them personally.

This feature automatically reinvests dividends in additional shares. Investing the available funds in your account will yield favorable returns over time.

3. Low commission

The brokers can set up drip, and the broker business may cut or eliminate commissions on reinvestments. It indicates that more money is being invested in stocks.

Not all broker businesses will eliminate the commission, so consult with your broker and be sure to check with your broker.

Cons

  1. Tax
  2. No diversification

1. Tax

If you participate in drip investments in taxable jurisdictions, you should be aware that you must pay 20 percent tax on reinvested dividends. The problem is that you must pay the tax by the due date, or else you may be required to sell shares to pay the tax.

2. No Diversification 

If you set up a drip investment for a certain stock, you will amass a substantial amount of that stock over time. This will decrease diversification and increase risk. It is recommended to periodically review and rebalance portfolios.

Setting up Drip

Brokerage firms will offer the opportunity to invest in drips. You can access your online account and select the option to reinvest dividends. You will be guided through the procedure by the navigation, and you can set up a drip investment.

Alternately, you can contact the investing broker or call center to start up drip investments. There are few businesses that offer their own drip investments. To obtain the benefit, you must contact them personally and utilize the advantages.

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