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Dividends 101 - The Beginner's Step-By-Step Overview of How Dividends Work

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Dividend Reinvestment Plans or DRIPs
Direct Stock Purchase Program DRIP

When you use direct stock purchase plans, dividend reinvestment plans, or DRIPs, you pay little or no commission. This leaves more cash in your pocket. Wall Street doesn't advertise these programs because if you use them, it loses the fee income.

Unless you need the money for living expenses or you are an experienced investor that regularly allocates capital, the first thing you should do when you acquire a stock that pays a dividend is enroll it in a dividend reinvestment plan, or DRIP for short.

How dividend reinvestment plans work

When an investor enrolls in a dividend reinvestment plan, he will no longer receive dividends in the mail or directly deposited into his brokerage account. Instead, those dividends will be used to purchase additional shares of stock in the company that paid the dividend. There are several advantages to investing in DRIPs; they are:

Benefits of enrolling in a dividend reinvestment plan

  • Enrolling in a DRIP is easy. The paperwork (both online and in print) can normally be filled out in under one minute.
  • Dividends are automatically reinvested. Once the investor has enrolled in a DRIP, the process becomes entirely automated and requires no more attention or monitoring.
  • Many dividend reinvestment plans are often part of a direct stock purchase plan. If the investor holds at least one of his shares directly, he can have his checking or savings account automatically debited on a regular basis to purchase additional shares of stock.
  • Purchases through dividend reinvestment programs are normally subject to little or no commission.
  • Dividend reinvestment plans allow the investor to purchase fractional shares. Over decades, this can result in significantly more wealth in the investor's hands.
  • An investor can enroll only a limited number of shares in the dividend reinvestment plan and continue to receive cash dividends on the remaining shares.
In fact, I like dividend reinvestment programs so much that I once wrote an essay for my friends explaining how my family had used the Coca-Cola dividend reinvestment plan to teach my youngest sister how to invest in stock. It became a learning experience so that by the time she reached high school, she understood the relationship between business, profits, dividends and investors.

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