A dividend reinvestment plan, or DRIP for short, are rules set by a broker according to your preference. The result is an automatic reinvestment of any dividends earned back into the same stocks, ETFs or REITs that generated them.
If you are unsure what dividends are, we strongly recommend you to read the linked article learning more about DRIPs.
The mayor advantage of using DRIP
Using a dividend reinvestment plan can lead to automatic execution. This saves you the time & effort of deciding what to do with earned dividends every time you receive one.
In addition to time, it also increases the effectiveness of the snowball effect. This is when your returns accumulate over time and increase exponentially, as you start earning dividends on your reinvested dividends. This approach is usually paired very well with dollar-cost averaging.
Your choice in a dividend reinvestment plan
DRIPs are mostly known for their automatic reinvestment feature. However, in most cases, you also get to choose an alternative option. If you prefer, instead of reinvesting the money into the same instrument, you can receive it as cash in your portfolio.
Choosing cash over reinvestment can be advantageous if you need money in the short term, or if you believe the current instrument is too expensive. Instead, you can then choose a different investment yourself, to spend earned dividends on.
Is DRIP for me?
DRIP is a logical choice for investors that invest in strong companies that pay dividends. Also called dividend aristocrats. As you expect to invest over the long term & have chosen stable companies, automatic reinvestment fits.
Dividend reinvestment programs can also make sense for those who want to always receive cash, as this is a rule that can be set as well. In this case, investors keep their freedom to invest by themselves, whilst still earning dividends.