Upbeat music plays throughout.
Narrator: Compounding returns are a powerful way for an investor to exponentially grow a portfolio over time. Investors can achieve compound returns from stocks, ETFs, and mutual funds by reinvesting dividends earned from owning those investments.
Many—but not all—companies issue cash dividends to shareholders, typically on a quarterly basis. These dividends are a way to share profits with investors.
As an investor, you could keep the cash you receive from dividends or use it to purchase additional shares of that company's stock.
A dividend reinvestment plan, or DRIP, allows you to automatically reinvest dividends to purchase additional shares.
Of course, you could buy additional shares any time. But because DRIPs are automatic, they can reduce complicated decision-making and allow you to "set it and forget it."
Imagine that there are two investors who own 100 shares of a company that is currently trading at $100 per share. This company pays out an annual 4% dividend. The first investor has enrolled in a DRIP, whereas the second investor keeps the cash from the dividends without reinvesting it.
Animation: The investor enrolled in a DRIP sees an increase in shares from 100 to 101 for a balance of $10,100.
Narrator: The DRIP allows the first investor to automatically buy an additional share of that stock during the first quarter.
Animation: The investor enrolled in a DRIP sees an increase in shares from 101 to 104.060 with a balance of $10,406.04.
Narrator: If the company continues to have a 4% dividend yield, after a year, this investor would own more than 104 shares, worth $10,400. During the next year, this investor is receiving dividends on 104 shares instead of just 100.
Animation: The investor enrolled in a DRIP sees an increase in shares from 104.060 to 105.101 for a balance of $10,510.10.
Narrator: So, this year, she receives more than an additional share.
From one year to another, these differences may seem small, but over a long period of time, they can really add up.
Animation: Hypothetical chart shows profits over 20 years between a DRIP participant and a non-DRIP participant. Investor not enrolled in a DRIP now has $18,000, and the investor enrolled in a DRIP has $22,167.15.
Narrator: Let's assume the stock's price is the same over the course of 20 years and has a steady dividend yield of 4%. For the investor who simply kept the cash from dividends, his initial $10,000 would now be worth $18,000. But for the investor who reinvested dividends, her initial investment would be worth more than $22,000—that's a 50% higher rate of return than the investor who kept the cash dividends.
Animation: The investor enrolled in a DRIP sees an increase in shares from 100 to 221.67 for a balance of $22,167.15.
Narrator: And this example doesn't even include potential gains from the stock's price appreciation.
Of course, investors always want the price of a stock to rise, but if it drops instead, a DRIP can actually take advantage of this situation as you'd be able to use your dividend to buy more shares at a lower cost.
To enroll in a DRIP for a new position, log in to your account at schwab.com. Go to the Trade tab at the top. Then, select Stocks & ETFs.
Below, you'll place an order. First, in the Symbol box, type in the company's name or ticker symbol. Then, from the Action menu, select Buy. Once you've made those two selections, you'll see the Reinvest Dividends checkbox; check the box to enroll in the DRIP.
You can also set up a DRIP on your current holdings too. Point to the Accounts tab at the top. Then, select Positions. Here, you'll find the Reinvest? column. Find the security you'd like to start a DRIP for and select the link in the Reinvest? column. A pop-up window will appear where you can make your selection. Then, select Update.
When you automate dividend reinvestments, the DRIP can buy more shares of your equities for you. And all you have to do is reap the compound returns.
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