Aug 14th, 2009
Working Backwards: What’s a DRIP (and a Synthetic DRIP)?
It’s been awhile since we’ve had a Working Backwards post here, but I thought to follow up on our previous discussion perhaps a better look at the term DRIP–dividend reinvestment program–would be useful.
We talked about what a dividend was previously and touched on a DRIP. What happens with a DRIP is that when a dividend by the company is paid out, instead of cash being sent to the investor, the dividend amount is used to buy more stock (often a fractional share of stock). Taxes must be paid as usual for the dividend even though it is not paid out in cash.
Companies which offer direct stock purchases often offer DRIPs as part of that program.
It is also possible in many cases to set up a “synthetic DRIP”. A synthetic DRIP is when stocks that pay dividends are owned in a conventional brokerage account and when those stocks pay dividends, the brokerage firm buys more stock with those dividends–just like a true DRIP. My Firstrade accounts offer this option, and I take advantage of it.
Why use a DRIP rather than take the cash? For one, it’s an easy way to invest without having to think about it. For another, it’s an opportunity to buy stock without commissions (in most cases) and to acquire fractional shares–which eventually can become full shares. And finally, it’s a way to keep investing at regular intervals–dividends are usually paid quarterly, so four times a year you acquire more shares.
DRIPs can make a lot of sense if you have dividend paying stocks. Remember this when you make investing decisions, and keep it in mind as we continue to address the question of investing for a child’s education.
