Whenever you receive a dividend, you may get asked if you want to participate in the "Dividend Reinvestment Plan".

In this article, I'll explain exactly what this means, what your options are and the pros and cons to participating.

What Is A Dividend Reinvestment Plan?

A Dividend Reinvestment Plan (also called a DRP or DRIP), is an option given to investors to forgo receiving a dividend in cash and automatically have it reinvested into more shares.

For example, imagine you have shares in Spark and they are about to pay you a $100 dividend. Assuming Spark has an active Dividend Reinvestment Plan, you have two options:

• Receive $100 in cash
• Reinvest that $100 into more shares.

By electing to reinvest, you allow your investment to compound which will lead to increased returns in the future.

Why Dividend Reinvestment Plans Are Beneficial

The maths is simple.

When you take your dividend in cash, the number of shares you own stays the same.

When you reinvest your dividend, the number of shares you own increases.

When your number of shares doesn't increase, your investment is not growing.

When your number of shares increases, so does your investment.

Let's look at an example.

Say you own 1,000 shares in Spark, and they're paying a 50 cent dividend.

Your dividend will therefore be 1,000 * $0.50 = $500.

To keep things simple, let's say the Spark share price stays at $5 for the next five years, and their dividend stays constant at 50 cents per year.

Here's how your investment will look if you reinvest compared to taking a dividend in cash:

As you can see, if you take your dividends in cash, your share count stays constant at 1,000 shares (obviously, because you are not reinvesting in any new shares).

This also means your dividend will always stay the same at $500.

However, if you reinvest your dividends, you can see your share count goes up. But this also means you dividend increases each year, as you now are earning dividends on more shares.

In just five years, you can see your dividend increased from $500 to $732 - almost a 50% increase.

You share count has also increased from 1,000 to 1,610. 

This is the power of compounding at work.

Over a period of 20 or 30 years, the difference will be substantial.

For example, if we move the decimal point to the right, your dividend would have grown from $5,000 to $7,320, or from $50,000 to $73,200. 

Over time this is a huge difference to your investment returns.

Other Benefits Of Dividend Reinvestment Plans

Your investment grows on autopilot

The great thing about participating in a DRIP is you don't have to manage your investment. Everything is done for you automatically - the company will manage the reinvestment for you and each dividend date you will see new shares pop up in your account. It's a very convenient way to improve the compounding on your investment.

No fees

When you purchase new shares through the DRIP, there are no brokerage fees. This can save you a substantial amount compared to if you were to reinvest the dividends yourself.

Dollar cost averaging

The great thing about a DRIP is you effectively purchase new shares at regular intervals during the year, meaning you automatically dollar cost average. This means even if you DRIP at the market high or low, it doesn't matter as it will even out over the long run.

Good money management on autopilot

Most people don't spend their dividends on anything important. They usually get paid into your bank account and then just get spent on miscellaneous things like food or gas. Obviously this does not go towards growing your wealth. By participating in a DRIP, you probably won't miss that little bit of extra cash each quarter, but as we saw above, those little amounts will slowly compound over time into something significant. It's a good way to enforce good money habits without having to do any extra work!

How To Opt In To Your Dividend Reinvestment Plan

When you purchase shares in a company, they will usually send you a form in the mail asking whether you would like to participate in the DRIP.

Simply indicate YES and return the form in the postage paid envelope.

Sometimes this form will be sent to you via email if you have an updated email address with the share registry.

You can also simply make the election online if you have set up your online account with the registry.

Almost all companies use LINK or Computershare as their share registry, and when you open your brokerage account, you should get all the details you need to set up your account online.

Then you can simply log in to LINK or Computershare and see all your holdings, as well as manage things like reinvestment plans.

For example, here's what it looks like inside Computershare. Simply head to the Reinvestment Plans page and elect which plans you would like to participate in:

Dividend Reinvestment Plans FAQ

What price do I pay for shares under a Dividend Reinvestment Plan?

Usually you will get a small discount to the market price (around 2%). After the DRIP has been completed you will receive a dividend statement detailing exactly how much you paid and how many new shares you received.

What happens if my dividend is not enough to purchase a full share?

Say your dividend is $50, and the price per share is $80, this means your dividend is not sufficient to participate in the reinvestment plan for that period. What will happen is your dividend will get held in the plan and added to your next dividend, until you have enough to make a purchase. So if the next dividend is also $50, that will be added to your earlier dividend of $50, giving you a total dividend payable of $100. Assuming the share price is still $80, you will then get one new share issued under the DRIP, with $20 leftover which, again, will be held until you have enough to purchase another full share.

Can I participate in Dividend Reinvestment Plans for my Australian shares too?

Usually DRIPs for Australian companies are limited to Australian residents. Therefore, if you are a New Zealand resident, you most likely will not be able to participate and will be forced to receive your Australian dividends in cash.

Is there a tax benefit to participating in the Dividend Reinvestment Plan?

There is no tax benefit to participating in a Dividend Reinvestment Plan. Whether you elect to take your dividend in cash or reinvest it, your dividend will be taxed under exactly the same rules.

Is it easy to opt out of the Dividend Reinvestment Plan later on?

Yes, it is very easy to opt out. Just log in to your Computershare or Link Market Services account and withdraw your election. You will then start receiving your dividends in cash again.