Have you ever heard the term 'dividend'? If yes, then congratulations! You are on your way towards financial betterment. But if not, don't worry, we'll explain everything to you. In this article, we will guide you on how to get dividends and reinvest them through a dividend reinvestment plan (DRIP). We'll also discuss the advantages and disadvantages of using a DRIP, so you can decide whether it's the right move for you.
What is Dividend?
In simple terms, dividends are a portion of the earnings that companies pay their shareholders. When you invest in a company's shares, you become one of its owners, and hence you get a share of its profits. Dividends can be paid in the form of cash, stocks, or other assets.
How to calculate the dividend amount?
The dividend amount is typically calculated on a per-share basis. For example, if a company declares a dividend of $2 per share and you hold 100 shares, you will receive $200 in dividends. Alternatively, you can use FinTok's Dividend Calculator to calculate the dividend amount. Just follow these steps:
- Access the Dividend Calculator on FinTok
- Select the stock you are interested in
- Enter the share amount
- Enter the stock price (or leave it as default for the latest price)
- Click "Calculate Dividends" and it will provide you with the dividend amount.
What is a Dividend Reinvestment Plan (DRIP)?
A dividend reinvestment plan (DRIP) is a program that enables you to reinvest your dividends back into the same company's stocks, instead of receiving the dividend amount in cash. In other words, a DRIP allows you to use the dividend amount to buy additional shares of the company. Essentially, this means your dividends will compound over time.
How does it work?
When you enroll in a DRIP, your dividend amount is automatically reinvested to buy more shares of the company's stocks. The process typically happens quarterly, but some companies may offer monthly or annual DRIPs as well. Over time, the additional shares you acquire through the DRIP will increase the size of your portfolio, which results in more dividend payments.
How to enable Drip?
To enable a DRIP, you need to open a brokerage account with the company that offers the DRIP. You can either open an account directly with the company or use a third-party brokerage that offers the DRIP. Once you have an account, you will need to enroll in the DRIP program, and the broker will take care of the rest.
Here are some popular brokerages that offer DRIP programs:
- Fidelity: Link to Fidelity DRIP
- WeBull: Link to WeBull DRIP
- TD Ameritrade: Call 800-669-3900 to enroll in the dividend reinvestment program.
- Charles Schwab: Link to Charles Schwab DRIP
- Wealthsimple: Link to Wealthsimple DRIP
- Questrade: Link to Questrade DRIP
- Robinhood: Link to Robinhood DRIP
DIY DRIPs
If you're interested in a company that does not provide a DRIP program and no brokerage or third parties can facilitate dividend reinvestment on your behalf, you have the option to manage dividend reinvestment yourself. This is known as a "Do-It-Yourself" or DIY DRIP.
In a DIY DRIP, you would directly purchase shares and fractional shares that correspond to the dollar value of your dividend payment. If fractional shares are not available, keep the dividend money until you have accumulated enough to purchase whole shares. This method requires more effort and attention compared to standard DRIPs, however, it still offers the benefits of compound returns and dollar-cost averaging over time.
Advantages of DRIP
- DRIPs (Dividend Reinvestment Plans) help you take advantage of dollar-cost averaging, a strategy where you buy shares of stock at regular intervals. This can lower the average price you pay per share over time.
- Some DRIP plans offer discounts on the current market share price for investors who reinvest their dividends.
- Dividend reinvestment plans generate compound returns, contributing to even more compound growth over time. According to an analysis by Hartford Funds, 78% of S&P 500 returns since 1978 can be attributed to dividend reinvestment and resulting compound returns.
Disadvantages of DRIP
Here are some potential disadvantages of using a DRIP:
- Risk concentration: By reinvesting your dividends back into the same company, you are concentrating your portfolio in that one company. Hence, if that company underperforms, your entire portfolio will suffer.
- No control over timing: Because the DRIP purchase happens automatically, you may miss out on potential opportunities, such as buying shares at a lower price.
If You Reinvest Dividends, Are They Taxable?
Dividend income is subject to taxation, even when reinvested back into the business. This is reported as income to the IRS on Form 1099-DIV. Dividends can be categorized as non-qualified or qualified. Non-qualified dividends are taxed at the ordinary income rate, while qualified dividends, which most American stocks and funds fall under, enjoy a more favorable tax treatment similar to long-term capital gains taxes.
It's important to note that not all dividends are created equal. Dividends from Real Estate Investment Trusts (REITs), employee stock options, or Master Limited Partnerships (MLPs) are not considered qualified dividends. These exceptions highlight the complexity of tax law and the importance of good record-keeping and staying informed on tax rules.
How to use FinTok's DRIP calculator
To use FinTok's DRIP calculator, follow these steps:
- Search the stock ticker to check if the company offers a dividend.
- Select the share price and the number of shares.
- Choose how much you want to contribute monthly and the number of years you want to hold the stock.
- Select the tax rate your dividend is subjected to. [Optional]
- Choose the dividend growth rate and the share price growth rate. [Optional]
- Finally, select whether you want to enable DRIP or not.
- The calculator will provide you with the DRIP calculation over the years, as well as the breakdown of how much you earn in dividends each year and your end balance.
Conclusion:
In conclusion, a DRIP is a great vehicle for long-term investors to grow their portfolios. By reinvesting your dividends, you can compound your returns and achieve a higher yield on your investment. However, before you enroll in a DRIP, make sure to weigh the pros and cons of this investment strategy and assess whether it aligns with your investment goals and risk tolerance.