If you’re a cryptocurrency trader and have never heard of a Dividend Reinvestment Plan (DRIP), this article will cover what DRIPs are, how they work, and how they’ve taken on a life of their own in cryptocurrency markets. Even if you’ve participated in traditional DRIP investing, you may want to stick around to read how they carry over to blockchain-based platforms.
Defining Dividend Reinvestment Plans
The meaning of a DRIP is pretty straight forward. It’s an investment strategy that enables investors to automatically reinvest the stock dividends they receive. When a company issues dividends with their stock, investors that own their stock receive a payment called a dividend, usually, this occurs quarterly.
Before Dividend Reinvestment Plans were instituted, these dividends were usually cashed out and sometimes manually reinvested in other equities or used as passive income. With DRIPs, investors can have their dividends automatically reinvested into the DRIP stock that issues the dividends. Additionally, they would not have to reinvest in one whole stock share at a time anymore but could purchase fractional shares of stock. In the world of traditional finance, DRIP stock investing has since become a go-to investment strategy.
Why are DRIPs Beneficial?
When DRIPs came on the scene over a decade ago, they were part of a movement called, financial democratization. This means that the pool of investors that could actually trade in stocks was widening in response to the Internet and new automation capabilities.
One of the most important benefits of Dividend Reinvestment Plans at the time was the absence of commissions. That’s because, at one time, brokerages charged a small amount for every standard trade. But during the last few years, many brokerage firms have given up on charging commissions for individual trades. Still, DRIPs offer many other advantages.
The advantages of DRIPs
- The automation of Dividend Reinvestment Plans enables people to set up their investment portfolios and have it essentially run itself. Each time a dividend is received through their broker, the money goes straight into more of the same stock.
- Another aspect of financial democratization involved with DRIPS was that investors no longer had to purchase one whole stock share. Instead, they could participate in “fractional shares.”
- DRIPs are an important tool for the long term investor. As a way to dollar cost average, reinvesting dividends by way of incremental and regular stock buys over time provides a way for investors to capitalize on compound interest.
- For some investors, DRIPs represent one way to get rich slowly with this multi-dimensional investment formula:
- Compound interest + fractional shares + automatic reinvesting + dollar-cost averaging = how to get rich
- Many other investors use DRIPs to invest in IRAs, 401Ks and pension plans. With these types of DRIPs, they do not pay taxes on the dividend income until they either take an early distribution (taxes and possible penalties) or a normal distribution (just taxes; required after a certain age).
Important note: This is not investment advice; please do your own research and consult a professional before investing in the stock market and/or cryptocurrencies.
Are there disadvantages to DRIP investing?
As with any investment strategy, Dividend Reinvestment Plans are not for everyone. In fact, there are at least four reasons why automated dividend reinvestment may not be the right choice:
- Short term investors may not feel that compound interest over the long term is something they need. Traders who more actively manage their own portfolios may feel the terms of the DRIP are constrictive.
- Some investors prefer to use the dividend disbursements as passive income. They may use the income for household bills, a child’s college education, or donation to a favored charity.
- The more DRIP stocks you have that issue dividends, the more instances you have of taxable income that you must claim in that year. That is, unless your DRIPs are through a pension, 401k or IRA. In those cases, the tax is usually deferred until later, regular distributions. When you want to cash out the stock that you reinvested with your dividends, you may have capital gains or losses to claim as well (unless held in pensions, IRAs, etc.)
- Bringing the last two reasons together, some investors may use the passive income from dividends to help pay the income taxes on dividends (unless it’s a nontaxable dividend, such as a capital return). With DRIPs, this is no longer an option.
The 2 main kinds of DRIPs
Brokerages and investment banks may offer DRIPs to their client base. They broker the stock purchases working individually with companies that issue the stock. They’re able to offer fractional shares by having many clients to pool stocks and by using automation.
Alternatively, investors are able to invest directly with company DRIP programs, such as with McDonald’s or Honeywell. Originally, DRIPs were introduced by such companies seeking to expand their investor base and have always been commission-free. Eventually, these plans expanded to brokerages, which at first charged commissions, but then later lifted the fees.
Whether an investor participates in DRIP investing through a company or a broker, there are usually no commission fees. The investor also enjoys an automated system of buying fractional shares whenever they receive their dividends. So no longer do they worry about having to buy one full share of stock. That can sometimes cost hundreds and or even thousands of dollars. Additionally, both types of DRIPs offer a way to dollar cost average small stock purchases. This method enables long term investing and a way to optimize compound interest.
So far, everything we’ve discussed on the DRIP front has related to stocks. But what about crypto? The good news is that these investment strategies have officially entered cryptocurrency markets. However, they exist in somewhat of a gray area when it comes to taxation.
At BlockFi, anyone with even just a few dollars worth of BTC can open up a BlockFi Interest Account. Other eligible cryptocurrencies include ETH, and LTC, as well as stablecoins USDC and GUSD. You can also use fiat to get started. The Interest Account issues quarterly dividends. As with traditional DRIPs, these dividends are automatically reinvested but this time it’s not in stock – it’s reinvested in bitcoin!
With Robinhood, their traditional asset exchange recently rolled out DRIP investing for their customers. They also own Robinhood Crypto, which offers cryptocurrency trading in most US states. We’d like to hope that two and two are put together and Robinhood’s cryptocurrency arm soon enables traders to auto-invest their stock dividends into crypto, hint hint!
It’s important to remember that when reinvesting cryptocurrencies into more crypto, the guidelines for taxation and what a dividend means in crypto are somewhat vague. The SEC considers all virtual currencies to be securities (even though some are not). So each time you receive a crypto payment, such as with the BlockFi interest account, that is taxable income that you are required to claim. When you cash it out later, just as with stocks, you’ll need to claim any capital gains or losses.
We hope you’ve found this article on DRIPs to be informative. We recommend the following reading to help bridge the divide between stocks and virtual currencies: