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Smart Investor Tip of the Day
These types of investments are overwhelmingly popular and are offered by about 1000 companies and funds. Simply put, a Dividend Reinvestment Plan is an equity investment allowing shareholders to purchase more stock of the underlying company directly instead of through a broker which would normally charge brokerage fees. Once set up this becomes an automatic process and dividends that are normally distributed to the investor will instead be used to purchase more shares (reinvested) of that company. One can usually also make voluntary cash payments into the DRiP to purchase more shares.
So although DRiPs start out as stock-earning dividends on regular intervals, each quarter those distributed dividends are collected and used to buy more shares of the underlying company at no cost (in most cases). And as you gain more shares you generate even more dividend income which then is used to buy more shares. Again, this is an automatic process.
Virtually all companies who take part do not charge commissions for purchasing stocks through DRiPs. However because of its growing popularity it is becoming more commonplace for a nominal fee to be charged to purchase more shares within the plan. So make sure you are aware of these fees, if any, when joining a DRiP.
Taking part in this type of plan provides the benefit of compounding and price appreciation without having to wait to accumulate enough cash for a full share (they are bought as partial shares, if necessary). That being said, there are two kinds of plans: classic and broker. The classic DRiP is what we’ve discussed here. The difference between the two lays in how and when shares are bought. Classic buys fractional shares; the broker type does not. So with a broker DRiP you must have enough money to purchase at least a single share before it is executed. This approach is horribly inefficient which is why you should always prefer the classic approach. Questrade, a popular discount broker, offers both types. In the classic type you would buy at least one share of the company through the online broker and then opt to receive the paper version of that share(s) and then fill out a DRiP enrolment form and have it sent to be processed at the underlying company.
So in many respects DRiPs are more of a get rich slowly method.