 Personal Finance PowerPoint Presentation Dividend Reinversement Plan, or DRIP, prepare to get financially fit by practicing personal finance. Most of this information comes from Investopedia Dividend Reinversement Plan, DRIP, which you can find online. Take a look at the references, resources, continue your research from there. This is by James Chen, updated February 9th, 2022. In prior presentations, we've been looking at investment goals, strategies, tools keeping in mind the two major categories of investments that being fixed income, typically bonds, equities, typically the common stocks. Also keep in mind the tools you are using, which might include mutual funds, ETFs, helping you diversify where you possibly might be using different strategies than you would if purchasing individual stocks, in which case you might be drilling down to the financial statements of those corporations themselves doing ratio analysis and trend analysis on them. Keeping that in mind, we're asking what is a dividend reinvestment plan, a DRIP. A Dividend Reinvestment Plan, DRIP, is a program that allows investors to reinvest their cash dividends into additional shares of fractional shares of the underlying stock on the dividend payment date. So remember, we're on the equity side of things, we're investing in stocks. Stocks are basically ownership shares of a corporation, corporations are a separate legal entity, separate legal entity, which ownership is typically broken out into individual shares. Most of the time we're talking about publicly traded companies, those which are traded on the public exchanges, and we're purchasing shares from there. The dividends represent the company taking earnings, typically earnings, and then distributing it to the owner in the form of dividends, dividends being similar to draws for partnerships and sole proprietorships, except that in a partnership, for example, me as one partner may be able to then say I want to draw a certain amount of money from the earnings that the company has made that might differ from draws of another partner. Whereas for a corporation, all the stocks need to have the same amount that is being distributed out of retained earnings, the income of the company that's been retained, so that you have this equality in the shares. That's kind of the point. And therefore, the dividends will be determined by the board of director and the board of directors and the management. And then the question is, well, if we're investing and we're getting dividends, then we're receiving dividends, we might be investing in a long term plan. So we might decide, hey, look, I'm not in retirement. I'm not living on the dividends. I don't want the cash dividends myself. I want to roll them back into the investment strategy. So we're going to ask and see if we have the capacity to possibly simply buy more shares with the dividends that have been distributed to us. So although the term can apply to any automatic reinvestment arrangement set up through a brokerage or investment company, it generally refers to a formal program offered by a publicly traded corporation to existing shareholders around 650 companies and 500 closed-in funds currently do so. So you're probably going to hear it in kind of a more broader kind of sense. In other words, whenever you're working in an investment strategy, you might be having this concept of rolling the dividends over or you might be talking about, say, an individual stock, which might have the capacity or give you the capacity to do this as well. Understanding a dividend reinvestment plan drip. Normally, when dividends are paid, they are received by shareholders as a check or direct deposit into their bank account. So they're just giving you the money that has been earned in the form of a dividend. Drips, which are also known as dividend reinvestment programs, give shareholders the option of reinvesting the amount of a declared dividend into additional shares, which are bought directly from the company. Because shares purchased through a drip typically come from a company's own reserve, they are not marketable through stock exchanges. Shares must be redeemed directly through the company also. So most drips allow investors to buy shares commission-free or for a nominal fee and add a significant discount to the current share price. They may set dollar minimums. However, most do not allow reinvestments much lower than $10. While drips are usually intended for existing shareholders, some companies do make them available to new investors, usually specifying a minimum purchase amount. So if you put the minimum amount in there for, like, again, you want to differentiate from an individual stock, right? We're talking about basically an individual stock or corporation giving you this option, which could be a benefit. And therefore, they might say, hey, if you put enough money in, we might give you this option. As opposed to, say, for example, if you're putting money into like a 401k plan, a mutual fund or something like that, where you might have this kind of reinvestment thing, which is similar but not exactly the same because now you're in a mutual fund where you're basically taking the proceeds you've received and reinvesting it back into your investment. So although the shareholder does not actually receive the reinvested dividends, they still need to be reported as taxable income. So meaning from a tax standpoint, when we're investing in stocks, typically the stock is going to give us a return in two ways. We're going to get growth on it. We're going to get a return either from dividends and or from the stock price going up in value, in which case we can sell it at a higher price. When they give us the dividends, we're typically our subject to taxation at that point in time. So even if they distribute the dividends and we just roll it over, we might want to be able to say to the tax, to the IRS say, hey, look, I didn't spend the money, but typically there's a taxable event there because you have access to the money and chose basically to put it back in. That would be the general idea of it. On the other hand, if they didn't give out the dividend and they put the money back into the company, then the value of the company might grow because they would be able to buy hopefully assets with that money generating future earning potential increase in the stock price. In that case, you're not usually subject to an income tax at that point because although the value of your stock has gone up, you haven't realized that value by selling the stock. So typically that kind of gain would be recognized at the point you sell the stock. So although the shareholders does not actually receive the reinvest dividends, they still need to be reported as taxable income. So you'll probably get a 1099 for the dividends unless they are held in a tax advantage account like an IRA. And that's a common exception to the rule because a lot of people have these kinds of investments in like an IRA or a 401k or something like that. It kind of confuses people I think because people start to think that the IRA itself acts a little bit differently or somehow special or something like that. The IRA is basically kind of an umbrella. So it's saying that you're going to defer the taxes typically on most of the IRAs until the point in time that you hit retirement and you take the money out. So in that case, even if you have the dividends then and you keep it in the IRA, you may not have a taxable event in that case until the point in time that you start pulling the money out in retirement. But if you had your money in a similar investment like a stock that was outside of the IRA, then of course you'd be subject to taxes like the normal taxation rules, dividends being taxed when you receive the dividends, capital gains when you sell the stock. Additional considerations for DRIPS. There are several advantages of purchasing shares from a DRIPS for both the company issuing the shares and the shareholder advantages for investors. DRIPS offer investors a way to accumulate more shares without having to pay a commission, which is nice. Many companies offer shares at a discount through their DRIPS from 1% to 10% of the current share price between a commission and a price discount that costs basis for owning the shares can be significantly lower than if the shares were purchased on the open market. Through DRIPS, investors can also buy fractional shares so every dividend dollar is really going to work. So long term, the biggest advantage is the effect of automatic reinvestment on the compounding of returns. When dividends are increased, shareholders receive an increasing amount on each share they own, which can also purchase a larger number of shares, so you're kind of like a compounding basically effect by reinvesting. So over time, this increases the total return potential of the investment because more shares can be purchased whenever the stock price decreases, the long term potential for bigger gains is increased. Advantages for the company, why would the company do this kind of thing? Dividend paying companies also benefit from DRIPS in a couple of ways. First, when shares are purchased from the company for a DRIPS, it creates more capital for the company to use. So they're selling more stock, the stock's going to make more money that's coming into the company, of course, although they're giving equity interest for those, so it's basically coming from the company as opposed to buying the stock, say from the stock market, from the secondary market, for example. Second, shareholders who participate in a DRIPS are less likely to sell their shares when the stock market declines. So if they have, they kind of lock in those investors because they got this cool benefit, which is kind of nice. So you might have investors that are a lot more committed in that case to the company doing well in continuing this mutually beneficial practice. Partly, that's because participants tend to be long term investors and recognize the role their dividends play in the long term growth of their portfolios. Of course, another factor is that DRIPS purchases share are not as liquid as shares purchased on the open market. They can only be redeemed via the company. Real world example of a DRIPS. The 3M company offers a DRIPS program administered by the company's transfer agent, EQ share owner services. It gives registered shareholders the option of using all or a portion of their dividends designed either by dollar percentage or by number of shares to buy shares. If they don't choose an option when they enroll in the plan, all their dividends will be reinvested. The company pays all fees and commissions.