Dividend Reinvestment Plans are a Great Way for Long-Term Investors to Build Wealth: Delay Taxes, Commission Free Purchase, Preferential Pricing…
Cash Dividend vs. Dividend Reinvestment
Cash Dividend Payout – Income
Typically this type of payment is a cash payment to the holder of the shares of the company paying the dividend.
Reinvested Dividend – Dividend Reinvestment Plan (DRIP)
Instead of receiving a quarterly dividend payment from the company, you can elect to have the dividend reinvested into a DRIP. This means that the dividend payment you would receive will be used to buy more shares in that company.
Advantages of Dividend Reinvestment Plans for the Investor
Flexibly Add Extra Funds To Your DRIP Account
You are also not merely limited to your dividends being in-invested to buy additional shares; you can also directly buy extra shares through the DRIP account.
Commission Free Share Purchase
If you have established a DRIP with a company that administers it’s own Plan, then the reinvested dividends will generally purchase the shares with Zero Commission, as no broker is acting as the middleman, therefore no brokerage fee.
Preferential Stock Prices
Another benefit of some DRIPs is that they will enable you to buy shares at a discounted rate. They can vary widely. I have seen some plans offering up to an 8% discount. And, did I mention Zero Brokerage Fees.
Applying Dollar Cost Averaging – More Shares Lower Prices
Point 2 above discussed the fact that you can purchase shares in addition to the reinvestment of your dividend payments.
But here is the smart thing.
If you apply the concept of Dollar-Cost Averaging to your purchases, you can reduce your overall average cost per share.
Dividend Reinvestment Plan Example
Dollar-Cost Averaging Benefit
|1 Payment $8,000||8 Payments $1,000|
|Quarter Purchased||Share Price||# of Shares||# of Shares|
|Total Shares Owned||800||830.13|
|Share Value Q8||$10,400||$10,791|
|$ Cost Average Benefit||0%||3.8%|
|Average Cost Per Share||$10||$9.64|
Table 1: Dollar Cost Averaging Example
In the example above, the investor has $8,000 to invest in shares.
Non-Dollar Cost Averaging
The first example is a single payment of $8,000, which buys 800 shares at $10 per share. At the end of 8 quarters the total share value is $10,400 – (Share Price in Quarter 8 * 800 shares)
In this example, the investor spreads the payment of $1,000 in 8 installments over eight quarters. As you can see, when the share price is lower, the investor gets more shares for each $1,000 invested.
When the share price is $7, the investor gets 142 shares for $1,000. Also, when the share price is higher at $13, the investor receives only 76.92 shares.
Assuming the share price distribution is equal across the eight quarters, the dollar cost average investor has, in the end, received a benefit of $391 (the difference between the share value of $10,400 in example 1 and $10,791 in example 2.
This means the dollar-cost averaging investor has a benefit of 3.8%, not only that; the average share price cost is $964 rather than $10 per share.
Advantages of Dividend Reinvestment Plans for the Corporation
Why would a company expend the extra resources and costs to run it’s own DRIP’s plans?
It all comes down to the business benefit.
Generating Extra Investment Capital
When a company goes public, it will receive the money generated from the Initial Public Offering (IPO) by selling a share of the business.
But after that, the buying and selling of the common stock on the stock exchange do not benefit the company as the exchange of shares is a transaction between private buyers and sellers, none of that revenue goes to the company.
But when you invest in a DRIP, and you receive your dividend in the form of shares or invest in extra stocks in your DRIP, the shares come from the company’s private share reserves.
Therefore if you invest $8,000 in your DRIP, the company directly receives that cash, onto its books as increased working capital.
Encourage Long-Term Investment
The stock market can be a volatile place, with stock prices fluctuating dramatically. Those people invested in DRIPS are in for the long-term and are unlikely to exit their investment during times of uncertainty. In fact, using dollar-cost averaging presents a real benefit to the long-term investor. Paradoxically during the bad times, the investors get more shares for their money.
Selling your Dividend Reinvestment Plan Shares is also not quite as straightforward as selling on an open stock exchange. When you sell, you sell back to the company, not on the open market. This means there is less liquidity, so for the company, this encourages more stability in the investor base.
Benefits Dividend Reinvestment Plans Summary
As you can see, if you are seriously committed to long-term investments, there are many advantages available to you to be able to increase your investment pot over time.
- Preferential Taxes through Qualified Dividends
- No Brokerage Fees for shares purchased through DRIPS
- Dollar-Cost Averaging over the long-term
- Discounts on Share Prices
- Deferred Tax Payments on unrealized Gains
It is definitely worth considering DRIPS as part of your investing plan.