Dividend Investment Plan (DRIP) is a program that allows shareholders to automatically reinvest their cash dividends in additional shares of the company. The company usually sets a limit on how many shares an investor can acquire in a single transaction, for example, up to 100 shares per DRIP purchase.

Some companies also offer “non-cash” DRIPs, which allow investors to automatically reinvest their dividends without buying shares. Investors who choose this type of plan should use dividend-paying stocks such as preferred stock, common stock, and money market funds.

A dividend reinvestment plan is a type of investment account that allows investors to reinvest or “turn over” their dividends to buy more shares in the company. The company pays cash dividends from its profits, then allows shareholders to buy more shares of the company with those funds. This basic strategy is called “dividend reinvestment”.

This investment form has become known for certain types of stocks, such as those that offer high dividend yields. The additional shares purchased with the reinvested dividends cost nothing extra, և if all goes well, they provide the individual shareholder with a capital appreciation in the future.

Advantages of DRIP:
There are three main benefits to having DRIPs, including:

  • DRIP allows an investor to achieve a significant increase in their investment over time.
  • The money the company receives from the reinvestment is used for expansion և growth, which benefits all stakeholders.
  • A dividend reinvestment plan can provide investors with a steady stream of income each time they reinvest in dividends, which is better than getting a lot of money at the end of the year.
  • Some companies offer discounts on stock purchase prices through DRIP, which can be useful for those who do not have a large investment amount.

Disadvantages of DRIP:

While an automatic reinvestment of your dividends may seem like an attractive idea, there are some drawbacks to these dividend reinvestment plans. Like any other form of investment, DRIPs have their drawbacks that must be considered before investing. These include:

  • DRIP may restrict your voting rights in the company.
  • You will also have to buy, sell, and liquidate your assets according to the company schedule at your discretion.
  • You may not be able to sell quickly in an emergency.

In India, a dividend reinvestment plan is available only to institutional investors such as banks, financial institutions and insurance companies. Individuals can also reap these benefits through portfolio management services offered by investing in special schemes created by mutual fund houses or stock exchanges.

Types of Dividend Reinvestment Plans (DRIPs)
There are three main types of dividend reinforcement plans (DRIPs).

  • Just a drop – It allows shareholders to directly reinvest their dividends in additional shares of the company.
  • Optional drop – They require shareholders to request a new stock, usually with instructions on how many to buy. these instructions can be as simple as three shares or five shares.
  • Mandatory DRIP – They oblige shareholders to reinvest their dividends to receive future dividends, effectively forcing them to become record holders instead of investors.

Regardless of the type, it is important for investors not only to know the existing software, but also to decide on the right one before using it. For example, some may include fees, և investors who do not take them into account may end up with a scenario where dividends are worth more than they are worth.

Example of dividend reinvestment plans (DRIPs)
XYZ is a company in Mumbai whose shares are available through various brokerage firms. XYZ recently created its own share buyout plan for shareholders who have 500 or more shares of their stock. Under these rules, shareholders who acquire 500 or more shares within 30 days immediately after the payment date are eligible to acquire additional shares under certain conditions. For example, if a shareholder acquires 10,000 shares of XYZ over his or her time, he or she will be able to buy up to five new shares for each share previously purchased. The purchase price of each new share will be 85% of the lower trading price between the two trading days before the conclusion of the purchase agreement.

Although not for everyone, dividend reinvestment plans can be a great way to invest in growing companies. Investing in DRIP is recommended if you want to accumulate significant shares in the company in the long run.

1. How do dividend reinvestment plans / DRIPs work?

The concept behind the Dividend Plan (DRIPs) is quite simple. You buy shares directly from the company, in return you receive dividends, which you then reinvest in more shares of the company. Each time you invest in a particular company’s stock, DRIPs allow you to accumulate additional stock over time without any commissions or fees.

This means that with each payment you make, your stake in that company automatically increases. It should be noted that while some companies offer their free DRIP services, many require participants to use their broker-dealer platform to take advantage of their dividend reinvestment plan. To start investing in a dividend reinvestment plan, contact your broker-dealer or IIFL about automated stock purchase և registration options so you can easily և use these programs cost-effectively.

2. Do I pay tax on reinvested dividends?
A common misconception about dividend reinvestment plans (DRIPs) is that they provide tax benefits. While your DRIP investments may increase over time as a result of your company’s profits, you will not avoid paying income tax or other tax benefits by participating in such an investment program. If you participate in DRIP և receive dividends, you are more likely to pay more taxes as your dividends will be taxed at the appropriate rates on their income. The only way to avoid capital gains taxes is to collect your dividends so that they can be deducted from your account without investment. However, you lose the compound interest that will accrue over time by investing in DRIP.