Dividend Reinvestment, or DRIP, involves which of the following?

• A. Dividends are automatically reinvested in the underlying equity rather than paid in cash.
• B. Dividends are paid out as cash to the investor each quarter.
• C. Dividends are used to buy bonds only.
• D. Dividends are taxed as capital gains immediately.

Answer: (A)

Dividend reinvestment plans take the cash you receive as dividends and automatically turn it into more shares of the same stock, instead of paying out cash. This means your investment compounds over time because you own more shares, and future dividends come from a larger amount of stock, often including fractional shares if your plan allows it. This automatic reinvestment is what makes DRIP different from taking cash dividends.

Dividends paid out as cash each quarter describe a plain dividend payout, not reinvestment. Using dividends to buy bonds only isn’t accurate for DRIP, which focuses on adding more shares of the underlying equity. Dividends being taxed as capital gains immediately isn’t correct either—dividends are typically taxed as income (qualified or ordinary) when paid, and reinvesting them does not convert them to capital gains right away.