The word "DRIP" is an acronym for dividend reinvestment plan, but DRIP also happens to describe the way the plan works. With DRIPs, the dividends that an investor receives from a company go directly towards the purchase of more stock, making the investment in the company grow little by little.
How DRIPs Work
Many companies offer shareholders the option to reinvest the amount of issued dividends into additional shares through a DRIP. Since these shares usually come from the company’s own reserve, they are not marketable through the stock exchanges. DRIPs must be redeemed directly through the company.
The "dripping" of dividends is not limited to whole shares, which makes these plans somewhat unique. The corporation keeps detailed records of share ownership percentages.
For example, if the TSJ Sports Conglomerate paid a $1 dividend on a stock that traded at $10, every time there was a dividend payment, investors with the DRIP plan would receive one-tenth of a share.
Lower Cost Way to Accumulate Shares
DRIPs use a technique called dollar-cost averaging intended to average out the price at which you buy stock as it moves up or down over a long period. You are never buying the stock right at its peak or at its low with dollar-cost averaging.
Company-operated DRIPS are popular with shareholders as a lower cost way to accumulate additional shares. There are no commissions or brokerage fees involved. Many companies offer shares at a discount through their DRIP ranging from one to ten percent off the current share price. Between the price discount and no trading commissions, the cost basis for owning the shares can be significantly lower than if the shares were purchased on the open market.
(To learn more, see The Perks of Dividend Reinvestment Plans.)