Investors can achieve compound returns from stocks, ETFs, and mutual funds by reinvesting dividends earned from owning those investments. Many, but not all, companies issue cash dividends to shareholders, typically on a quarterly basis.
These dividends are a way to share profits with investors. As an investor, you could keep the cash you receive from dividends, or use it to purchase additional shares of that company's stock.
A dividend reinvestment plan, or DRIP, allows you to automatically reinvest dividends to purchase additional shares.
Dividend Reinvestment Plan | Simple Steps for a Retirement Portfolio Course
Of course, you can buy additional shares any time. But a benefit of using a DRIP is that you avoid the commissions and fees normally associated with purchasing stock.
Because DRIPs are automatic, they can reduce complicated decision-making and allow you to “set it and forget it.”
Imagine that there are two investors who own 100 shares of a company that is currently trading at $100 per share.
This company pays out an annual 4% dividend.
The first investor has enrolled in a DRIP, whereas the second investor keeps the cash from the dividends without reinvesting it.
The DRIP allows the first investor to automatically buy an additional share of that stock during the first quarter.