Although the acronym dividend reinvestment program, or DRIP, is not very impressive, investors should not make the mistake of believing that this strategy is perfect.
A dividend reinvestment strategy can be a powerful tool to outperform traditional long-term investing strategies.
What is a DRIP? And, most importantly, how can it help long-term income investors. This will help you understand it better.
- What is a DRIP?
- DRIPs and compound interests: A closer look
- There are some drawbacks to using a DRIP.
What Is A DRIP?
First, investors invest in stocks that pay dividends. Dividends are periodic profit-sharing payments that shareholders receive, usually once a quarter.
You will receive a fixed amount for every share as long as the company has a dividend program.
Dividend aristocrats are some of the most trusted income stocks that you can buy. Dividend Aristocrats Companies listed in the S&P 500 have a 25-year history of increasing dividend payments for investors.
Second, “reinvestment” means that you use the dividends to buy more shares and not spend them elsewhere. Even if you start with 100 shares, you could end up with 105 shares within a year. Or 1,500 shares if patience is required.
A DRIP is an easy way to instantly deploy cash. Many investors can do this independently since hundreds of funds and stocks offer direct DRIPs. Many online brokerage websites offer automated dividend reinvestment plans. You can create a DRIP if the stock pays a dividend.
A DRIP is not the right choice if you are looking to make quick money on Wall Street. Dividend reinvestment plans are a better option if you want to invest long-term with lower risk.
A Case Study In DRIPs & Compound Interest
Let’s take the example of telecom giant AT&T, and show you how this strategy works.
AT&T stock traded at around $29 in 2011, according to the company. Let’s suppose you invest $2,900 and buy 100 shares.
For a total price of $1.72 per share, the stock paid four quarterly 43 cent dividends. This yields a 6% dividend yield. You get paid back 6% of the purchase price of your stock ($29), over the course of the year’s dividend distributions.
The math is easy with 100 shares. This adds up to $172 in dividends that you would have earned on this specific $2,900 investment. This amount would purchase you six additional shares of stock. Instead of receiving a cash payment of 6%, you will receive a 6% stock payment (six shares for your initial 100-dollar investment).
This is a lot of math. But here’s the fun part. Add 6% to your 106 shares at the beginning of 2012 to get 112.36. Many brokerage platforms and dividend-reinvestment plans permit fractional shares. Add 6% to 112.36 in 2013, and you will have 119.1 shares.
You will have 179.1 shares if you fast-forward to 2021 after the 6% compounded over ten years.
This is called compound interest because each year you receive an interest payment, the next year’s payment will be even greater. Warren Buffett, a legendary investor, used compound interest to accumulate billions of dollars worth of wealth.
This post was written by All Seasons Wealth. At All Seasons Wealth, we provide expert advice and emphasize the importance of creating in-house portfolios to personalize your strategy for asset management, financial planning, and cash management. We utilize research and perform market analysis to provide you with financial planning in Tampa. No matter your needs, we can work with you to develop a consulting solution tailored to you.
Any opinions are those of All Seasons Wealth and not necessarily those of RJFS or Raymond James. Investing involves risk and you may incur a profit or loss regardless of the strategy selected. Investing involves risk and you may incur a profit or loss regardless of the strategy selected. Every investor’s situation is unique and you should consider your investment goals, risk tolerance, and time horizon before making any investment. Past performance may not be indicative of future results.