Financial Glossary
Dividend Reinvestment Plan (DRIP)
A dividend reinvestment plan (DRIP) is an arrangement that automatically uses an investor's cash dividends to purchase additional shares, often fractional, of the same security instead of paying the dividend out in cash. Reinvested dividends compound over time because each new share generates its own future dividends. Many plans allow share purchases with little or no commission and sometimes at a slight discount to market price.
Problem & Application
For business owners and individuals building long-term wealth alongside their operating income, a DRIP is a low-effort way to compound returns, but it creates a bookkeeping and tax wrinkle: reinvested dividends are generally taxable in the year received even though no cash hits the bank account, and each reinvestment establishes a new cost basis lot. Failing to track those lots leads to overpaying capital gains tax when shares are eventually sold. Clean recordkeeping of every reinvestment is what keeps a DRIP from becoming a tax-time headache.
In Short
A DRIP quietly compounds an investment by turning every dividend into more shares, but each reinvestment is a taxable event with its own cost basis. Disciplined basis tracking is essential to capture the benefit without overpaying tax later.