Automatic Reinvestment Plan

Posted in Finance, Accounting and Economics Terms, Total Reads: 348
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Definition: Automatic Reinvestment Plan

This is an arrangement which allows shareholder or an investor to authorize the dividend or capital gain payments to be reinvested in additional shares or mutual funds. In an automatic reinvestment plan, the capital gains realized by the fund can be used to buy more shares rather than giving it back to investors in cash.


This plan allows an investor to transfer his/ her amount from one account to another electronically.


Principle:

Consider the example of a mutual fund. The investor deposits his/ her amount into the checking account. The fund manager reinvests this amount into his mutual fund account.

Dividend Reinvestment uses Automatic Reinvestment Plan. The procedure is explained as follows:

Say, there is a reinvestment plan by General Electric (GE), administered by HSBC Bank’s Shareowner Services. All common shareholders of the company can participate in the ARP. Any broker or agent can also participate on behalf of the shareholder.

After enrolment, HSBC Bank enrols the shareholders account under the Dividend Reinvestment Plan. Investments can be made by automatic reinvestment or by cash. Then, HSBC combines all funds received from all investors and purchases bulk company stocks.

After every purchase, HSBC sends each participant the statement of accounts in detail. The participants have voting power for the shares in their account.


Advantages:

• Enables the investors to acquire more number of shares

• Avoids payment of excess tax

• More reinvestment gains over a period of time to the investors due to compounding

• This plan helps a firm develop to a higher range because the capital gains and dividends of the firm are reinvested back into the firm in the form of share capital

Investors usually refer to the prospectus of the firm to see if they have the option of Automatic Reinvestment Plan. Also, they verify if their mutual fund has this option and further tax liabilities. If the firm is expected to grow in future, the investor then goes forward with this plan.


Precautions to be taken:

• The procedure of dividend payments by the firms should be known. Because, in case the firm does not give dividends for the year and the ARP goes ahead, then amount from the investors savings would be utilized

• There might be a fee involved in buying additional shares through ARP

• The reinvestment should be done only after considering the opportunity cost if shares of other companies are purchased

 

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