Dividend reinvestment plans (DRIP): letting payouts compound

Instead of taking dividends as cash, some investors reinvest them to buy more shares. A dividend reinvestment plan, or DRIP, does this automatically. This guide explains what a DRIP is and how it works.

Quick answer

A dividend reinvestment plan, or DRIP, automatically uses the dividends you receive to buy more shares or units instead of paying cash. This lets your investment compound over time, as each reinvested dividend can earn future dividends. DRIPs are common in mutual funds and some company share plans.

Key takeaways

• A DRIP reinvests dividends to buy more shares or units.
• It replaces a cash payout with extra holdings.
• It helps your investment compound over time.
• It is common in mutual funds and some share plans.
• You give up current income in exchange for growth.

What is a dividend reinvestment plan?

A dividend reinvestment plan, or DRIP, is an arrangement where the dividends you earn are automatically used to buy more shares or fund units instead of being paid to you as cash.

So each time a dividend is due, rather than reaching your bank account, it goes straight back into buying more of the investment. Over time, this steadily increases your holding.

How does a DRIP work?

When you choose a reinvestment option, the value of each dividend is used to purchase additional shares or units at the price on the reinvestment date. These are added to your holding automatically.

In mutual funds, this is often offered as a growth or reinvestment plan. The effect is that your number of units keeps rising without you doing anything each time.

Why do investors use DRIPs?

The main appeal is compounding. When dividends buy more shares, those new shares can earn dividends too, so your investment can grow faster than if you spent the cash.

For long-term investors who do not need the income now, reinvesting can be a simple, hands-off way to keep building their holding.

What are the trade-offs?

The main trade-off is that you give up current income. If you rely on dividends for cash, a DRIP is not suitable, since the money is used to buy more shares instead.

There can also be tax to consider, as reinvested dividends may still be treated as income depending on the rules at the time. Please check the current position before you rely on it.

How should investors decide?

Choosing a DRIP comes down to whether you want growth or income. Those building wealth over years may prefer to reinvest, while those needing regular cash may prefer to take the dividend.

A DRIP is one tool among several for handling dividends, alongside a scrip dividend. Any investment decision should be your own after proper research and reading all related documents.

Frequently Asked Questions