The drops of rain make a hole in the stone, not by violence, but by oft falling.
Part of good investing is understanding that you will only succeed through compounding the effects. There's an old joke about compound interest being the most powerful force in the world, and while it wasn't actually said by Albert Einstein, its still worth noting.
In investing terminology DRIP stands for Dividend ReInvestment Program. There are several kinds of programs, both run by individual companies, by mutual funds, and by trade houses. But they all operate on basically the same premise.
When a stock or fund pays a dividend, the owner of that holding can opt to have the funds reinvested in that stock or fund instead of taking the cash. The funds are used to buy whole or partial shares and these are credited to the account. there are many benefits and a few drawbacks to be aware of.
- You can often avoid commission fees. When you are first starting out, commissions can be a large problem as they eat into profits. Most DRIP programs are free, and will purchase the shares without charging you anything. This can be very meaningful when you look at stocks that can a monthly dividend.
- The purchasing of small amounts of shares over a long period of time allows you to cost average. You will never be able to fully time the market, and this takes the stress out of worrying about that part. The shares you purchase will never be a large part of your portfolio since most dividends are less than 0.75% of the value of your current holding.
- You are putting the money to work right away. The dividends don't sit in an account, accruing no interesting. Instead they are now part of your ownership of a company. Again this can be especially meaningful if you are looking at monthly dividend companies.
- Its automatic! The first thing every investment expert will tell you is that automating your savings is critical. You are saving money without having to actively do anything. If you find yourself losing track of days and trying to get your "to do" list accomplished, this is now one less thing to worry about.
- First and foremost, you have to remember you still need to pay taxes on these dividends. When you are getting cash, you understand its value, understand it is income, and expect to pay taxes. Under a DRIP system, you don't really notice or appreciate the value you've received. Instead you simply see the number of shares you own go up.
maywill be over overpaying for some of your shares. You don't control when the dividend is paid, nor do you control when the shares are purchased. Some trades take place during the first thirty minutes of the trading day which are always more volatile. Sometimes you may be purchasing stocks on an up day. In theory the value of the share should drop by the price of the dividend, but in practice it is never a one to one relationship.
- You will likely receive partial shares. These are extremely difficult to trade. Normally you can not sell a partial share. So you will have these until you sell your entire holding. With some trade houses, you may need to contact customer service for help with this.
I held off on setting up a DRIP for several months. My original plan was to simply add any received dividends into my next large purchase to super charge them. The reality was that this didn't happen as cleanly as I would have likely. You can't always buy partial shares, so having an extra $15 to buy stocks with didn't help when shares cost $30. I also wanted to try to only buy shares when my systems indicated it was a good time to buy, But I was fretting over pennies and missing the big picture. So recently I coded my entire Tradeking account to automatically DRIP any dividends that came in. This was a free service, but requires an email to their associates. I has already automatically purchases a wuarter share of GM (GM)and a half share of America Realty Capital (ARCP).
For more information on using DRIP to your advantage I strongly recommend you take a look at this site: The DRiP Investing Resource Center