Many of the UK’s best-known companies pay dividends, and for long-term investors the question is what to do with that cash. One popular answer is a dividend reinvestment plan, often called a DRIP. It is a simple idea, but over years it can make a big difference to returns.
What a dividend reinvestment plan is
A dividend reinvestment plan automatically uses your dividends to buy more shares in the same company or fund, instead of paying the cash into your account. Some companies run their own plans through their share registrar, and most investment platforms offer automatic reinvestment on shares, investment trusts and funds. With funds, the equivalent is choosing the accumulation version, where dividends are reinvested inside the fund.
Why it matters: compounding
The power of reinvesting comes from compounding. Each reinvested dividend buys more shares, and those extra shares then earn dividends of their own, which buy more shares again. Over long periods, reinvested dividends have made up a large part of the total return from the UK stock market, because the FTSE 100 has historically paid out a high share of its profits as dividends.
A simple example
Imagine you own 1,000 shares priced at £5, worth £5,000, paying a 5 per cent dividend. In year one you receive £250. Reinvested at £5, that buys 50 more shares, so next year you receive dividends on 1,050 shares. If the share price and dividend stayed the same, after ten years you would own around 1,630 shares rather than 1,000, without adding any new money. If the dividend grows over time, the effect is stronger still.
The points to check
There are a few practical details worth checking. Some plans charge a small dealing fee per reinvestment, which can eat into small dividends. Reinvestment usually happens at the market price on a set date, so you do not choose the price. And in the UK, reinvested dividends are still treated as dividends received for tax purposes when shares are held outside an ISA or pension, so you need to keep records. Inside an ISA or SIPP, that is not a concern.
It is also worth remembering that reinvesting automatically means you keep adding to the same company. If that company already makes up a large part of your portfolio, you may prefer to take the cash and spread it elsewhere.
How investors use DRIPs
DRIPs suit long-term investors who do not need income today and want to build their holdings steadily. Reinvesting regularly also means you buy more shares when prices are low and fewer when they are high, a form of pound-cost averaging. Investors who need income, such as retirees, usually take dividends as cash instead. Our guide to dividend cover explains how to judge whether a dividend is sustainable in the first place.
Common mistakes
A common mistake is reinvesting into a company whose dividend is at risk, chasing a high yield that later gets cut. Another is forgetting about concentration as holdings grow. A third is ignoring fees on small reinvestments, which can add up over time.
The bottom line
A dividend reinvestment plan turns payouts into more shares and lets compounding do the work. It is a simple, low-effort tool for long-term investors, as long as you check the costs, the tax position and the quality of the dividend. If you want to understand your own approach to investing and trading, try the free Samuel & Co Trading Trader Assessment.
