Dividend Reinvestment Plan

A dividend Reinvestment plan is an option opted by the investor to reinvest the amount of cash dividend payable by the company to that investor. The reinvestment is into the new shares of the underlying securities on the date of the dividend payment. Thereby saving the brokerage and other fees incurred if the same cash is used to purchase the shares from the market.

Another term for it is DRIP. The investors have an option to reinvest their dividends to purchase additional shares of the underlying stock on the dividend payment date rather than taking the dividend out. Most DRIPs allow the shareholders to buy shares at nil commission and a discounted price. In general, the price discount varies from 1% to 10%.

In a typical scenario, a person receives dividends from a share through checks or bank transfers. However, in the case of DRIP, dividends are not received by the investor. Instead, they automatically purchase more shares of the issuing company. Further, the DRIP is not traded on exchanges and hence is not marketable directly. Dividend Reinvestment Plans are typically issued from the company’s reserves and thus are redeemable through the company itself.

Investing in DRIP vs. buying shares directly through cash dividend received:

Say One has stocks of ITC limited at INR 300 each, and suppose it pays a half-yearly dividend of approximately INR 6.0 per share. So if one holds 1000 shares, the half-year dividend would be INR 6000.0. For understanding, let’s assume the half-yearly dividend and the share price remains constant for the next six years. So, if one enrolls the ITC restricted shares for Dividend Reinvestment Plan with the above condition, the first half-year dividend will let one buy 20 additional shares:

However, consider if one doesn’t go for DRIP and goes about reinvesting the dividends on their own through brokerages:

If, in the same scenario as mentioned above, say the brokerage per share is INR 10.0 and commission and taxes include INR 5 per share. The first dividend of INR 6000 will provide 19 shares and a cash balance of INR 15 (1200 – a cost of 19 shares – brokerage for 19 shares – commission + taxes for 19 shares). Thus:

There is a difference of 12 shares in both cases. It may not seem like a huge difference at first, but it makes a huge difference for a long-term purpose. Further, if we consider that Dividend Reinvestment Plan shares are available at a discount of 1% to 10% from the market price, it will add to the value creation.

• Dividend Reinvestment Plans allow the shareholders to reinvest their dividends without charging additional commissions or brokerage. If a person goes directly to reinvest their dividend from the company through brokerages, they will have to pay brokerage/commission. It will make it a costly way of investment. Hence DRIPs are a cheaper way of dividend reinvestment.
• DRIPs provide an option to purchase fractional shares. For Example, A person is holding 105 stocks of a company. It currently trades at INR 100 each and receives a dividend of INR 5 per share. So the person will receive a dividend of INR 525. In the case of the DRIP, considering the stock price of INR 100 per share, a person will receive an additional 5.25 shares in his account.
• In the case of the Dividend Reinvestment Plan, the reinvestment of dividends happens in shares at a price lower than the current market price. It is not the case with manual reinvestment.
• This plan is particularly suitable for long-term investments. They allow the shareholder to accumulate more shares without investing additional money from their regular income.

• Shares are not as liquid as one purchased in the open market. One needs to approach the company to sell shares and hence cannot readily sell shares considering sudden market condition changes.
• Not suitable for short-term investors as it does not provide significant returns
• The company decides the purchase price of stocks. Hence investors have no control over the purchase price. Further, if a person wants to average out its cost price in case of a sudden stock price downturn, it is impossible since there is a timeframe for optional additional cash investment for DRIP.

• Most DRIPs don’t charge fees or commission/brokerage, but nowadays, it is becoming a trend to charge a nominal fee to invest in DRIP shares. The fee may range from a few INR to tens or hundreds of INR, depending on the current prevailing price of a stock in the market. It is essential to check for any initial fees or commissions for the plan. If so, one needs to consider that while assessing the plan's profitability.
• Some DRIPs require investors to become shareholders of record—registering shares in the name of individuals and not any brokerage. After becoming a shareholder of record, one must apply for a DRIP purchase to the company.
• DRIPS also offers optional cash payments wherein one can further invest cash directly into DRIPS. However, the timeline for optional cash payments varies from company to company. Further, a maximum and minimum optional cash investment are defined. Thus, one needs to consider that before investing in Dividend Reinvestment Plans.
• Though one does not receive the dividends in their account, one has to pay dividend payout tax in the case of DRIPs as well. It is a common notion that if they have not received the cash dividends in their account, why do they have to pay taxes on it. Thus one needs to consider the tax implications while calculating the returns of the Dividend Reinvestment Plan.

Dividend Reinvestment Plan (DRIP) is a good investment strategy, especially for the long term. Still, like any other investment instrument, one needs to do proper research work and due diligence before investing in DRIPs. One must consider the company's background, the industry in which it operates, its financial strengths, future growth prospects, etc. These plans may become a massive cost for the investor if taken without proper consideration.

This article has been a guide to the Dividend Reinvestment Plan (DRIP). Here we discuss its definition along with an example. Here we also discuss its advantages and disadvantages. You may learn more about financing from the following articles –

• Dividend Examples List
• Dividends Types
• Dividend Policy Definition
• Qualified Dividends