PortalKota – Dividend Reinvestment Plan | Simple Steps for a Retirement Portfolio Course. Compounding returns are a powerful way for an investor to exponentially grow a portfolio over time.
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.
If the company continues to have a 4% dividend yield, after a year, this investor would own more than 104 shares, worth $10,400. During the next year, this investor is receiving dividends on 104 shares instead of just 100.
So this year, she receives more than an additional share. From one year to another, these differences may seem small, but over a long period of time, they can really add up.
Let’s assume the stock’s price is the same over the course of 20 years and has a steady dividend yield of 4%. For the investor who simply kept the cash from dividends, his initial $10,000 would now be worth $18,000.
But for the investor who reinvested dividends, her initial investment would be worth more than $22,000–that’s a 50% higher return than the investor who kept the cash dividends.
If the second investor were to have purchased additional shares outright, he’d have to pay commissions, which would cut into his profits.
But the first investor bought an additional 122 shares of that stock without paying commissions. And this example doesn’t even include potential gains from the stock’s price appreciation.
Of course, investors always want the price of a stock to rise, but if it drops instead, a DRIP can actually take advantage of this situation as you’d be able to use your dividend to buy more shares at a lower cost. To enroll in a DRIP, go to tdameritrade.com.
From the My Account tab, select Dividend Reinvestment, and then Enroll/edit to customize your preferences.
From here, you can select individual positions to enroll in a DRIP, or you can choose to enroll all of your current and future eligible stocks and ETFs into this plan type.
You can also reinvest mutual fund distributions. If you elect to enroll in these distributions, you can reinvest cash from dividends and any capital gains distributions, which are profits.
When you automate dividend reinvestments, the DRIP can buy more shares of your equities for you. And all you have to do is reap the compound returns.