Introduction
When a company generates profits, it can use them to reduce debt, reinvest, or distribute as dividends among shareholders. Dividends serve as rewards given to shareholders for their investments. Generally, they are paid on a per-share basis every quarter. So, if you hold 100 shares of a company paying Rs. 10 as a dividend, you will receive Rs. 1,000.
The shareholders of a dividend-paying stock can receive the dividends in cash or as additional shares by reinvestment. With cash dividends, you have an immediate income to save, spend, or use however desired. However, the option to reinvest lets you add more shares of the same company to your portfolio, resulting in higher potential long-term returns.
How does dividend reinvestment work?
When you choose to reinvest dividends, you use the dividend payment to buy more shares of the dividend-paying stock. Many companies offer Dividend Reinvestment Plans (DRIPs) to make it easier for investors.
Start Investing with Free Expert Advice!
DRIPs allow you to invest your cash dividends into more company shares automatically. Usually, the company restricts the number of shares you can buy in one transaction. For instance, you can buy a maximum of 100 shares in every DRIP buy.
Cashless DRIPs let investors reinvest their dividends automatically without purchasing stock. To opt for the cashless plan, you must keep dividend-paying stocks as common, preferred, and money market funds.
A DRIP acts as an investment account, enabling you to reinvest or “roll over” your funds to buy extra company shares. The investment strategy is popular for specific stocks, especially those providing high dividend yields. There are no extra charges for the additional shares purchased with reinvested dividends. Besides, if everything proceeds in the right direction, the individual shareholder enjoys capital appreciation in the future.
Types of Dividend Reinvestment Plans
DRIPs can be classified into three main types.
1. Direct DRIP: This plan lets shareholders invest their dividends directly into additional company shares.
2. Optional DRIP: In this plan, shareholders must request new stock, mentioning how many they want to purchase. The number of shares can be three, five, etc., depending on the shareholder’s requirement.
3. Mandatory DRIP: This plan makes it compulsory for shareholders to reinvest dividends to earn future dividends. In a way, it forcibly makes them owners on record instead of investors.
Benefits of dividend reinvestment plans
DRIPs carry several benefits for investors.
- They let investors leverage dollar-cost averaging, which means purchasing fewer shares when prices are high and more when prices are low. As a result, the investor’s average share price lowers and potential gains increase.
- DRIPs help in growing wealth at an accelerated rate through compounding returns.
- Investors can create a diversified portfolio by reinvesting dividends in various companies across different sectors and industries. But these companies must offer DRIPs.
- DRIPs make investors disciplined by giving them a long-term perspective and keeping them away from emotional decisions based on market fluctuations.
- Investors can create a steady income stream with dividend reinvestment. This is better than receiving a large sum at the year’s end.
- The DRIPs of some companies provide discounts on share purchase prices. This aspect is beneficial for those with a small investment amount.
Demerits of dividend reinvestment plans
Most investors find automatic reinvestment of dividends attractive, but there are some disadvantages, too. Like other investment forms, DRIPs have demerits you should know about before investing.
- A DRIP eliminates your ability to sell quickly during emergencies.
- Your voting rights in the company may also be limited.
- You will have to follow the company’s schedule instead of your decisions to buy, sell, and liquidate your assets.
Conclusion
Reinvesting your dividends can help increase profits and grow wealth in the long term. You can opt for a manual or automatic dividend reinvestment plan based on your investing strategy and convenience. If you reinvest your dividends, you can create a steady income stream every time you reinvest. Moreover, you can enjoy diversity, dollar-cost averaging, long-term focus, and compounding. But remember that your dividend reinvestment is subject to taxation at the prescribed rates. Thus, discuss with a tax expert before reinvesting dividends.
Trending Blogs: NSE Holidays 2024 | BSE Holidays 2024 | Invest in Small Cap & Mid Cap Mutual Fund & Stocks | Companies affected by Rise in Crude Oil Price | Fall in IT Stocks | Launch of 4 New Indices | Revised Lot Size of Nifty Contracts | Impact of RBI Circular on Currency Trading | RBI’s New Lending Guidelines | Electric Air Taxis in India
Financial Calculators: SIP Calculator | SWP Calculator | Compound Interest Calculator | EMI Calculator | FD Calculator | Retirement Calculator | Option Value Calculator | Inflation Calculator | Lumpsum Calculator
Popular Stocks: ICICI Bank Share Price | HDFC Bank Share Price | CDSL Share Price | UPL Share Price | TCS Share Price | BHEL Share Price | Trident Share Price | IRFC Share Price | Adani Power Share Price