Dividend Reinvestment (DRIP)
Dividend reinvestment, often run through a DRIP (dividend reinvestment plan), automatically uses the cash dividends a stock pays to buy additional shares of the same stock instead of paying the cash to the investor. Over time this compounds returns: each reinvested dividend buys more shares, which then earn dividends of their own. Many plans buy fractional shares and charge little or no commission.
Worked example
An investor holds 100 shares of a $50 stock that pays a $2.00 annual dividend, generating $200. Instead of taking cash, the DRIP reinvests it: $200 ÷ $50 = 4 new shares, raising the holding to 104 shares — which next year earn 104 × $2.00 = $208 in dividends.
Why it matters
Dividend reinvestment is a low-effort way to harness compounding, and small holders benefit from commission-free fractional purchases. The pitfall to watch is tax: in a regular taxable account, reinvested dividends are still taxed as income in the year received, even though no cash reaches your pocket. Reinvesting also concentrates more money into a single stock, which can reduce diversification.
Frequently asked questions
Are reinvested dividends taxed?
In a standard taxable account, yes — reinvested dividends are taxed as income in the year they are paid, just like cash dividends. In tax-advantaged accounts they can compound without immediate tax.
How does dividend reinvestment grow returns?
Each dividend buys more shares, and those extra shares pay dividends of their own. This compounding effect accelerates over long periods, so total return outpaces simply taking the cash.
Related terms: Dividend Yield, Compound Interest