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Knowing the Advantages of Dividend Reinvestment Plans

For dividend stock investors who are looking to build wealth over the long haul, few (if any) investment programs can compete with the many advantages dividend reinvestment plans (DRIPs) offer. A DRIP is one type of direct investment plan (DIP). Instead of buying shares on the stock market, you purchase shares directly from the company on a regular basis. Dividends automatically go toward purchasing additional shares, and in many plans you can buy additional shares outside of the dividend-funded purchase, either as a one-time purchase or on a regular basis.

Don’t let the fact that a company has a DRIP or a DIP be the reason you invest in it. Research the company’s fundamentals first. Only after identifying companies you want to invest in should you concern yourself with whether the companies offer DRIPs or DIPs.

Buying dividend reinvestment plans on a budget

DRIPs are very similar to mutual funds in that they’re good for investors starting out with very little capital. With a minimal investment, you can purchase stock in small quantities with low or no fees.

The one big difference is that mutual funds provide you with a portfolio that’s diversified to some degree. With DRIP purchases, you own the stock of just one company. Sure, you can diversify your portfolio by enrolling in a number of DRIPs, but it’s more costly and complicated than buying mutual fund shares.

One major benefit of DRIPs over mutual funds is that with DRIPs, you don’t get stuck paying another investor’s tax bill. You have to be careful about your timing when you’re buying mutual funds so that you don’t end up paying taxes on profits that someone else collected.

Investing in DRIPs at your own pace

Although all DRIPs require a minimum investment to join the plan, you generally have the luxury of investing at your own pace. On top of reinvesting dividends on a regular schedule, these plans offer you the ability to buy more shares through the plan, often with no commissions. This enables you to make additional investments — regularly or only when you have some extra money to invest.

Saving on broker commissions

DRIPs eliminate the middleman (the broker who charges a commission to process every transaction) because you purchase stock directly from the company that issues it, saving you a ton of money in transaction costs. Compared to a mutual fund, you avoid the load charged every time you make an investment and the hefty management fees deducted from the fund’s assets.

The less you shell out in broker commissions, the more money you have to invest.

Taking the emotion out of stock investing

Investing can get emotional. When the market is going well, euphoria drives Wall Street into a buying frenzy, with investors screaming “Buy! Buy! Buy!” In the midst of dramatic economic downturns, fear drives the herd. Those same investors who were once yelling “Buy! Buy! Buy!” are now frantically trying to “Sell! Sell! Sell!”

When you buy a DRIP and commit to investing on a regular schedule, the market’s movements have little effect on how you invest. In good times and bad, you calmly and coolly acquire shares, building wealth slowly and more surely.

Compounding growth one drip at a time

With DRIPs, you don’t receive a dividend check tempting you to cash it out and fly to Aruba or use it to pay bills. Every penny in dividends is automatically reinvested for you to purchase additional shares of the company. These additional shares produce dividends, too. By allowing the dividends to be reinvested, you tap into the power of compounding growth without ever having to think about it.

Purchasing fractional ownership

When you purchase stock through a broker, you can’t buy a half or a third of a share. With most DRIPs, as with mutual funds, you can. Suppose you earn $100 in dividends, and shares cost $35. Instead of buying only two shares for $70 and having the extra $30 sitting on the sidelines, you can buy 2.86 shares and put all that money to work for you immediately.

Dollar cost averaging without lifting a finger

DRIPs are a perfect way to implement a dollar cost averaging strategy — investing a fixed (or in the case of DRIPs, a semifixed) amount of money regularly over time. You don’t even have to lift a finger because the plan automatically reinvests your dividends for you, purchasing shares on a regular basis regardless of current market conditions or share price.

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