Question of the week: What is a dividend reinvestment plan?

A dividend reinvestment plan (DRIP) is a plan offered to equity investors that allows them to reinvest their dividend payments instead of receiving it in cash. The dividends are reinvested in additional shares, or in some cases fractions of shares of the underlying equity.

A DRIP can be offered directly from the company that has issued the original shares, or can also be offered through a broker in what is known as a synthetic DRIP.

A DRIP operated by a company is done through their transfer agent. Through this kind of DRIP you can often purchase shares at a discounted price, sometimes 2 to 5 per cent less than regular price, and you are able to buy fractions of share which means all of your dividend is used for the reinvestment. For example, let’s say your dividend is $45 and shares are valued at $25. If this instance you could purchase 1.8 shares with your dividend payment.

If you setup a synthetic DRIP through a broker you will only be able to purchase whole shares, not fractions. This means in our $45 example above you would be able to purchase one $25 share and the remaining $20 would be paid in cash. The number of shares you can purchase with a synthetic DRIP will depend upon the share price and the amount of dividends you receive.

Some DRIPs may cost you money upfront for you to be able to enroll in the plan. Make sure you know all costs of entering the plan before doing so.

A DRIP may be a good investment tactic dependent on your investment goals and whether you believe there is a better way to use your dividend. Always do your due diligence and explore all investing and financial options for your money before entering any investment or investment plan.