Dividends are often paid in cash and the shareholders can do whatever they want with the money. Some people rely on this money for living expenses, while others place it into a savings account or certificate of deposit. Another option is to use the money to purchase more shares of stock, allowing the dividends to compound.
If the company offers a dividend reinvestment plan, or DRIP, the investor can enroll in this and the dividends will automatically be reinvested to purchase additional shares. Even some mutual funds permit investors to opt for automatic dividend reinvestment. Other companies allow investors to make voluntary contributions used to purchase shares.
To set up a dividend reinvestment plan, investors can use a full-service broker that will allow them to reinvest dividends from owned stocks. They can also utilize an online discount broker that offers DRIPs, and this and the first option allow investors to keep all their stocks in one location. An alternative is to purchase stock directly from the company. Investors can also buy stocks through a bank transfer agent.
Taxes are paid on dividends, so investors should think about placing dividend reinvestment stocks into a retirement account to protect the dividends from any current tax liability. In addition, some plans charge high fees for reinvesting dividends. Investors should research these prior to making any purchases because these fees reduce potential profits.
Reinvesting dividends to purchase additional shares is a smart move because it puts this free money to work for the investor. It also allows individuals to take advantage of dollar cost averaging when buying shares, which can save them money over the long term. Using the dividend payment to buy more stock in the company results in compounding of the dividends. More dividend payments are received in the future due to owning more shares.
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