How Dividend Reinvestment (DRIP) Works
DRIP automatically uses dividends to buy more shares. It's the easiest way to compound your returns over time.
What Is DRIP?
DRIP (Dividend Reinvestment Plan) automatically uses dividend payments to purchase additional shares of the same stock or fund. Instead of receiving cash, you get more ownership.
Most brokers offer DRIP for free. You just check a box, and dividends automatically compound.
How It Works
- Company pays dividend (e.g., $0.50 per share)
- You own 100 shares → You receive $50 in dividends
- With DRIP: $50 automatically buys more shares (fractional shares allowed)
- Next quarter: You own 100+ shares, earning slightly more dividends
- Repeat forever = compound growth
The Power of Compounding
📊 DRIP vs Cash: 20-Year Comparison
Starting: $10,000 in a stock with 3% dividend yield, 6% annual price growth
DRIP advantage: ~$14,000 more over 20 years
DRIP Benefits
Automatic Compounding
No effort required. Dividends reinvest automatically without you doing anything.
Dollar-Cost Averaging
You buy shares at whatever price they are when dividends pay out. Over time, this averages out your purchase price.
Fractional Shares
DRIP buys fractional shares. If your dividend is $23.47 and the stock is $150, you get exactly 0.1565 shares. No wasted cash.
No Commission
DRIP purchases are free at all brokers. You're not paying to reinvest.
DRIP Drawbacks
Taxes on Phantom Income
Even though you didn't receive cash, reinvested dividends are taxable. You owe tax on dividends you never saw.
In a taxable account, you need cash from somewhere else to pay the tax bill. In an IRA, this doesn't matter.
No Control Over Timing
DRIP buys at whatever price exists on the dividend payment date. You can't wait for a dip or decide the stock is overvalued.
Complicates Cost Basis
Every DRIP purchase creates a new tax lot with a different cost basis. After years of DRIP, you might have hundreds of tax lots. This complicates tax reporting when you sell.
When to Use DRIP
- Long-term investing — You don't need the income
- Retirement accounts — No tax on reinvested dividends
- Building wealth — You want maximum compounding
- Hands-off approach — Set it and forget it
When NOT to Use DRIP
- You need income — Retirees living off dividends
- Stock is overvalued — You'd rather deploy cash elsewhere
- You want control — Prefer to choose when to buy
- Tax simplicity — Don't want to track many tax lots
How to Enable DRIP
At most brokers, DRIP is a simple toggle:
- Fidelity: Account Settings → Dividends and Capital Gains
- Schwab: Account Settings → Dividend Reinvestment
- Robinhood: Settings → Investing → Dividend Reinvestment
- Vanguard: Account → Profile → Dividends and Capital Gains
You can usually set DRIP per position (reinvest Apple dividends but take Tesla as cash) or account-wide.
DRIP in IRAs vs Taxable Accounts
IRAs: Always Use DRIP
No tax consequences for reinvesting. Maximum compounding with zero downsides.
Taxable Accounts: Consider Carefully
DRIP creates taxable events even though you didn't receive cash. If you're in a high tax bracket, you might prefer taking dividends as cash and deploying them strategically.
The Bottom Line
DRIP is the simplest way to maximize compound growth. For most long-term investors, especially in retirement accounts, it's a no-brainer.
The key question: Do you need the income? If no, turn on DRIP and let compounding work its magic. If yes, take the cash.