Dividend Reinvestment Plan (DRP)
Definition:
A Dividend Reinvestment Plan (DRP) is a program that allows shareholders to automatically reinvest their cash dividends into additional shares or fractional shares of the issuing company’s stock. Instead of receiving the dividends in cash, they are used to buy more stock of the company, often at no additional cost or at a discounted price. Reinvested dividends are taxable when credited to the shareholder’s account, even though no cash is received. The reinvested dividends increase the shareholder’s basis in the stock, so it is critical to retain all records for the calculation of gain or loss upon sale.
Examples
Example 1: Mary owns 100 shares of XYZ Corporation, which pays a $2 per share annual dividend. She enrolls in XYZ’s DRP, so instead of receiving $200 in cash, the $200 is used to purchase additional shares of XYZ Corporation.
Example 2: John has 150 shares of ABC Inc. ABC issues a quarterly dividend of $1.50 per share. John opts for the DRP and thus reinvests his $225 quarterly dividend into buying more ABC shares at current market prices.
Frequently Asked Questions (FAQs)
Q1: Are reinvested dividends under a DRP still taxable? A1: Yes, reinvested dividends are taxable in the year they are credited to the shareholder’s account, even if no cash is received.
Q2: How do DRPs affect the basis of my stock? A2: Reinvested dividends increase the basis of your stock. This means the original cost plus any reinvested dividends will form the total basis for calculating gain or loss upon sale.
Q3: Can I enroll in a DRP at any time? A3: Enrollment periods may vary. It is best to check the specific company’s DRP guidelines for enrollment periods and conditions.
Q4: Are there any fees associated with enrolling in a DRP? A4: Some companies offer their DRP with no fees or at a discounted rate; however, this varies by company.
Q5: Will participating in a DRP always generate more returns than taking dividends in cash? A5: Not necessarily. While a DRP can potentially lead to greater stock accumulation and benefit from compound growth, the actual returns depend on the stock’s market performance.
Related Terms
Shareholder Dividend: Payments made to shareholders from a company’s earnings or profits.
Stock Basis: The original value or purchase price of an asset, which is adjusted for dividends reinvested, and used to calculate capital gains or losses.
Capital Gains: The profit realized from selling a stock at a higher price than the original purchase price.
Fractional Shares: Portions of a stock that are less than one full share, often resulting from DRPs or stock splits.
Online References
Suggested Books for Further Studies
- “The Intelligent Investor” by Benjamin Graham
- “Dividends Still Don’t Lie: The Truth About Investing in Blue Chip Stocks and Winning in the Stock Market” by Kelley Wright
- “Investing Made Simple: Index Fund Investing and ETF Investing Explained in 100 Pages or Less” by Mike Piper
- “Bogle on Mutual Funds: New Perspectives for the Intelligent Investor” by John C. Bogle
Fundamentals of Dividend Reinvestment Plan (DRP): Investing Basics Quiz
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