"Drip" investing lets you invest in companies directly, thus completely or mostly bypassing your brokerage and its commission fees. It lets you invest small amounts, and it reinvests dividends you receive in additional shares (or fractions of shares).
Traditional Drip plans were extremely valuable in the past, and many investors benefited greatly from them. However, these days they're no longer so necessary, since many online discount brokerages are now offering dividend reinvestment -- along with commission rates that are significantly lower than they were a decade or two ago.
When you consider some of the downsides of traditional Drips, such as excessive paperwork and difficulty tracking small purchases, you may want to look to a brokerage account instead. Some discount brokers now try to make purchase and sale tracking easier for their customers.
Of course, many people switch brokers from time to time, and you clearly won't want to lose valuable purchase and cost-basis data. Storing this kind of information elsewhere, including Quicken or other money-tracking software, is a good idea. (Note that changing brokerages can be a smart move, since the brokerage you're using may not be the best one for your needs.)
Meanwhile, if you're interested in having your brokerage reinvest your dividends, you have several options. Schwab
Reinvesting is powerful
Reinvesting dividends can be a powerful way to get wealthy. These eye-opening examples would have produced huge gains over the years, thanks to reinvested dividends:
Procter & Gamble
(NYSE:PG): $2,000 invested in P&G 30 years ago is now worth more than $125,000.
(NYSE:PEP): $2,000 invested in Pepsi in 1980 is worth more than $190,000 today.
- $2,000 in Chevron
(NYSE:CVX)bought three decades ago would now be worth more than $42,000.
- With just $2,000 in Exelon
(NYSE:EXC)shares in 1980, you'd have slightly more than $105,000 now.
You can see just how powerful dividends can be -- even without adding a single penny to your original investment. Over time, you'll often find that your dividends grow so large that you'll earn more than your total original investment every year in dividends alone!
Sidestep the accounting
You can neatly sidestep the headache of record-keeping for reinvested dividends by making those reinvestments in a tax-advantaged account, such as a Roth IRA.
Alternately, simply let your dividend income accumulate in your brokerage account until you have enough cash to deploy into a new investment -- another stock holding, or even a new batch of shares in an existing holding. In this situation, you're controlling how many batches of a stock you purchase, and you're more easily able to invest in other companies. This option will give you much of the benefit of reinvesting dividends, but with fewer tax hassles along the way.
Reinvesting dividends shows just how powerful long-term investing can be. By keeping your money working for you, you can make it grow that much faster -- getting you where you want to be that much sooner.
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This article was originally published on Sept. 24, 2007. It has been updated by Dan Caplinger, who doesn't own shares of the companies mentioned. Exelon and Coca-Cola are Motley Fool Inside Value picks. Charles Schwab is a Motley Fool Stock Advisor recommendation. Coca-Cola and Procter & Gamble are Motley Fool Income Investor recommendations. The Fool owns shares of Procter & Gamble. Try any of our investing services free for 30 days. The Fool is Fools writing for Fools.