Personal finance tools have never been more available for anyone with internet access. Technology has now made something that has typically been foreign to many individuals, easily accessible, more user friendly, and most importantly….FREE! In this article I am going to discuss what a DRIP is and recommend a good website for you to refer yourself to.
For those of you who are not too savvy on personal investing and finance, you may find yourself wondering “what is a DRIP”? A DRIP is an acronym for a direct reinvestment plan. This method of investing is a way to build up a personal stock portfolio by reinvesting dividends into the same company that issued them.
For example, lets say you own 100 shares of General Electric (GE) and each share is currently selling on the market for $10. GE issues dividends to shareholders for $1 per share. By owning those 100 shares, you will be receiving a check from GE for $100. If you chose to directly reinvest it, however, you would be able to purchase shares of GE equal to the $100 of dividends you would received (in this case you would get 10 shares). This is beneficial because as an investor you are able to waive commissions that would normally have to be paid if you were to take the $100 and purchase the GE stock…if you paid $10 for commission you would only be able to get 9 shares.
This form of investing is a great way to take an investment and help it continue to grow with minimal intereference, as well as side-stepping commissions. Another advantage is being able to purchase the stock at the different prices (you buy when its low as well as its high)…lets assume now that GE’s share price dropped to $9 per share and it still issues $1/share in dividends. By DRIP investing, you would be able to own fractions of shares as well as purchase more shares because GE dipped a little. In this case, $100 of GE stock would fetch you 11.11 shares.
The most important method of DRIP investing is the idea of compounding gains. The concept of compounding is taking every gain and adding it back to the initial investment pot. As Einstein once declared compound interest “is the most powerful force in the universe”.
It is important to note that this form of investing is not all tea and cakes, there are two key downsides. Firstly, you still have to pay capital gains tax on the dividends, which can be tricky. If you do not reinvest you can take some of the money that would be given to you through the check and put a portion towards taxes, making your cash flow much easier. The second downside is that it forces you to reinvest into that company…which can prevent you from taking that dividend and putting it into a more profitable investment.
With all of this said, I want to refer you to a useful free tool which is one of many that the internet has to offer. I like the following calculator because you can use many different variables, including average annual gain, as well as taxes that will have to be paid:
http://www.hughchou.org/calc/drip.php
Regardless of whatever method you use to invest, always make sure to keep yourself grounded and prevent your emotions from getting the best of you and making you commit to rash decisions. I hope you found this article to be helpful, and I will be coming out with many more!
