3 Benefits of Setting up a DRIP

Dividend stocks are great. Dividend yield can provide a boost to your portfolio, increasing your returns. You can couple dividend yield with price appreciation to get the most out of your stocks. However, there is another tool you can use to make the absolute most out of your investments: a DRIP.

DRIP stands for ‘Dividend Reinvestment Plan.” This means that all dividends you receive will be used to purchase extra shares of that stock. DRIPs are an excellent tool that a surprising amount of investors don’t know about.

1. Compounding Returns With a DRIP

Compound interest is a magical thing. This is why a DRIP is so powerful. Using a DRIP, you can exercise the true power of compound interest.

Consider stock XYZ, which provides $0.30 per share per year in dividends. The stock is trading at $10 per share, so this is a 3% yield. If you own 100 shares of this stock, you have $1000 invested and receive a 3% yield from dividends.

Now, if you set up a DRIP with that stock, you can see how powerful of a tool it is. If you own 100 shares, you earn $30 in your first year. At the end of your first year, your DRIP purchases 3 more shares of XYZ. This is assuming it is still trading at $10 per share.

At this point, you have 103 shares of XYZ. This doesn’t seem like a lot of growth, but this is why we preach a long-term strategy.

Thinking long-term, we can calculate this type of return over 30 years. Over that span of time, your investment of $1000 will more than double to $2,427. Just from your DRIP, you have purchased an extra 147 shares of XYZ.

Let’s put this in context. You have more than doubled your investment without putting any more of your money into it. Therefore, you’re buying an extra 142 shares of XYZ at little to no cost to you.

Now add in a modest 4% return in price appreciation. This gets you to a total of $7,612. All of this from just one of your investments, without adding any principal. Factor in regular contributions and a diversified portfolio of 10-20 stocks, and you see the true power of a DRIP.

2. Don’t Pay Commission on Your DRIP

When I first heard about DRIPs, I assumed having one would destroy me in commissions. However, I use Questrade as my brokerage and their DRIP is commission-free! This means that, to an extent, you can dollar cost average your stocks without paying commissions.

By avoiding commissions, you will save a ton of money rather than if you were trying to purchase more shares down the road. In our previous example, we purchased an extra 142 shares of XYZ. Keep in mind that this was done periodically, a few shares at a time. If you tried to do this without a DRIP, you would lose hundreds of dollars in commissions!

3. Your DRIP Can be Passive

At this blog, we are firm believers in passive investing. A lot of that has to do with inherent human nature and the way we let our emotions get in the way of investing. In addition, stocks can be incredibly complicated. Thus, if we let our emotions dictate our purchases, we may end up losing.

By setting up a DRIP, you don’t need to decide what to do with dividends. In addition, you’re less likely to keep checking up on how your stock is doing. This is because you know that more money will be contributed every quarter or so.

By setting up a passive strategy, you’re able to focus more on other things. While not truly 100% passive, you’re still doing as little work as possible while maximizing your returns.

A DRIP program is an excellent tool for investors. This is particularly true for investors who want to maximize the passivity of their portfolios. Using a DRIP, you can buy extra shares of your stocks without adding any money, paying any commissions, or executing the trade yourself!

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