DRIPing Our Way to Financial Independence
Almost 25 years ago, shortly after graduating from college, I made a series of seemingly minor decisions that in retrospect helped set me down the path towards financial independence and early retirement.
I had been interested in the stock market for some time, and as an aspiring adult, I thought I should do some research on how to begin investing now that I was earning a regular paycheck.
While perusing the personal finance and investing shelves at the local bookstore in those pre-Amazon.com days, I stumbled onto a tome about Dividend Reinvestment Plans, also known as DRIPs.
As soon as I finished reading the book, I knew that DRIPs were something I needed to get involved with. DRIPs offered the opportunity to invest directly in the stock of companies, with a minimal amount of money, sometimes at a discount, and frequently without having to pay a brokerage commission – which was a much bigger deal before online trading!
So What Exactly is a Dividend Reinvestment Plan (DRIP)?
A Dividend Reinvestment Plan (DRIP) is a program offered by a company that allows its shareholders to reinvest dividends paid by the company into additional shares of its stock. Instead of receiving cash when the company pays its dividend, you receive additional shares (or fractions of shares!) in the company.
For example, let’s assume you own 100 shares of XYZ Corp. (XYZ), which pays a $0.25/share dividend quarterly, and are a participant in its DRIP.
XYZ stock is priced at $20 on June 15th, when it pays its quarterly dividend. Because you own 100 shares of XYZ, you are entitled to $25 in dividends (100 shares times $0.25). Because you are a participant in XYZ’s DRIP, instead of getting that dividend paid in cash, the company gives you an additional 1.25 shares of its stock ($25 in dividends divided by the $20 share price).
When the next quarter rolls around, you now own 101.25 shares of XYZ stock, and the $25.3125 in dividends you are entitled to (101.25 shares times $0.25) are invested to buy more shares for your account based on the price of XYZ stock on September 15th.
Over time, DRIPs can enable an investor to grow their portfolio by harnessing the power of compounding. Every time a dividend is paid you will own more shares of the company. If the company increases the amount of its dividend, you will benefit because you own more shares than you would have had you not reinvested your previous dividends.
Many DRIP plans also allow stockholders to purchase additional shares directly from the company, oftentimes without having to pay a brokerage commission. If you want to purchase an additional $100 of stock in the company, just transfer the money directly to them or their transfer agent, and the additional shares will be added to your account.
In some cases, you don’t even need to be a current shareholder to set up a DRIP – you can simply set up an account and transfer money to buy shares at the current market price. Some companies also allow DRIP participants to purchase shares at a small discount to the current market price of their stock!
Sounds Interesting – So What Kind of Companies Offer DRIPs?
Literally hundreds of American companies offer DRIPs. Some of the most prominent companies that offer DRIPs include 3M, AT&T, Cisco Systems, ExxonMobil, IBM, Johnson & Johnson, J.P. Morgan Chase, Nike, Pepsico, Procter & Gamble, and Verizon.
You should be able to figure out if a company sponsors a DRIP by visiting the Investor Relations portion of their website or calling their Investor Relations department.
Computershare has a list of DRIPs it is the transfer agent for here.
Dripdatabase.com has a more expansive list of DRIPs here (although some of the information appears to be out of date).
What Are Some of the Potential Drawbacks of Investing in DRIPS?
- First and foremost, the terms and conditions of each DRIP are unique. Many companies allow you to reinvest your dividends and make optional cash purchases for free, but others charge brokerage or other fees on each transaction in your account. While these amounts are generally modest, they can add up over time. Some DRIPs offer discounts on purchases, while others do not. Some DRIPs allow you to make your initial purchase directly, while others require that you already own shares of their stock. Some DRIPs allow you to make optional cash purchases in relatively small amounts, while others require larger investments. Some DRIPs require you to reinvest your entire dividend, while others allow you to reinvest a portion of your dividend in new stock and receive the balance in cash. Make sure you do your research and understand exactly what you are getting into before investing any money in a DRIP.
- Even though you won’t receive cash when you reinvest your dividend into additional shares of stock, you will still need to pay tax on the full amount that was paid as a dividend.
- When it comes time to sell a stock you owned via a DRIP, it can be some work to determine your cost basis, since that position may have been built over a period of many years via many relatively small transactions. You’ll need to keep good records when investing in a DRIP!
- It’s hard to time the market when investing in a DRIP. You’ll be reinvesting your dividends automatically at whatever the stock price happens to be on the day the dividend is reinvested. Optional cash purchases are often made at the end of the day, and it may take time for your funds to transfer to the company. XYZ stock may be priced at $22.50 when you decide you want to buy an additional $500 of shares at 11 a.m. on a Tuesday. The actual stock price when that $500 in finally invested for you is likely to be different.
How Have You Used DRIPs in the Past, ROMT?
As I mentioned earlier, I first learned about DRIPs about 25 years ago.
After I got my first full-time job following college, I did some research on DRIPs and decided to invest in two companies: Exxon Corporation (now ExxonMobil) and our local bank.
My initial purchase of Exxon was for $250, which bought me 3.74 shares at $66.85. My initial purchase of the local bank was for $300, which bought me 14.724 shares at a price of $20.375.
Over the next few decades, I made many additional optional cash purchases in both companies. Early in my career, I made a purchase of $50 here or $75 there. Once I was earning more, I would buy a couple hundred dollars in additional shares on occasion.
Throughout this time period, the quarterly dividends that each company paid were also reinvested to purchase even more shares. My first dividend reinvestment in Exxon was for $2.69, which bought me 0.041 additional shares given the stock price of $65.077 in September 1993. My first dividend reinvestment in the local bank was for $2.90, which bought me .134 additional shares given the stock price of $21.58.
Fast forward to today, and I now generate more in dividends each year from both ExxonMobil and the local bank than I initially invested in either of those companies!
That, to me, demonstrates the potential power of DRIPs for buy and hold investors. DRIPs are certainly not a get rich quick scheme. But if you identify a company you believe in for the long term that increases its dividend steadily, reinvest those dividends over an extended period of time, regularly add to your position through optional cash purchases, and the stock price also increases over the years, you can eventually amass a reasonably sized position – $50, or $25, or even $2.69 at a time!
Dividends from ExxonMobil and the local bank together now generate over 15% of our passive income, and almost 5% of what we expect to need annually when we reach financial independence and early retirement. Not a bad return from those initial investments of $250 and $300 many years ago, along with dozens of relatively small additional purchases over the years via dividends and optional cash investments. The power of compounding in action!
I haven’t made any optional cash purchases in either DRIP over the past several years, but we continue to reinvest our dividends into more shares each quarter. When we do begin early retirement, we’ll most likely “flip the switch” on those accounts and begin to request the dividends in cash, rather than additional stock, to help fund our expenses.
I didn’t know about the concept of FIRE 25 years ago.
But in retrospect, my decision to invest in DRIPs was an important early step on the journey that helped us move down the path towards financial independence and early retirement!
Have you invested in DRIPs in the past? What did you like – or not like – about this method of investing?