investment

Reviewed by Thomas Brock
Fact checked by Suzanne Kvilhaug

Companies can do several things with their profits. They can keep them as retained earnings, reinvest them to help them grow, or share them with their investors as dividends. Dividend payments are decided by the board of directors and must be approved by shareholders. These payments can be issued as cash or as shares of stock.

But what happens when a company needs to cut its profit-sharing? A dividend cut occurs when a dividend-paying company either completely stops paying out dividends or reduces the pay out. This most often leads to a sharp decline in the company’s stock price, because this action is usually a sign of a company’s weakening financial position, which makes the company less attractive to investors.

Key Takeaways

• Dividend cuts are most often a negative sign for a company’s financial health.
• Companies usually make drastic dividend cuts because of financial challenges like declining earnings or mounting debts.
• Sometimes companies may cut dividend payments for more positive reasons, like preparing for a major acquisition or a stock buyback.

Financial Reasons

Dividends are usually cut due to financial reasons like weak earnings or a funding crunch. Typically, dividends are paid out from the company’s earnings, and if earnings decline over time, the company either needs to increase its payout rate or access capital from other places, such as its short-term investments or debt, to meet the past dividend levels. 

If the company uses money from non-earnings sources or takes up too much of the earnings, it may put itself into a compromising financial position. For example, if it has no money to pay off its debts because it is paying out too much in dividends, the company could default on its debts. It usually won’t come to this, though, as dividends are usually near the top of the list of things cut when the company is faced with financial challenges.

This is exactly why dividend cuts are seen as a negative. A cut is a sign that the company is no longer able to pay out the same amount of dividends as it did before without creating further financial difficulties.

Note

Some of the most common industries that pay dividends include financials, oil and gas, utilities, healthcare, and basic materials.

Room for Growth

While most investors rightly consider a drastic dividend cut a negative sign for a company’s health, it isn’t always such a harbinger of doom for a company. 

Under certain conditions, when the pricing and conditions are just right for a stock buyback; weathering a major recession becomes the priority; or a company needs to accumulate cash on hand for a big merger or acquisition. 

In these cases, a dividend cut—even a rather drastic one—may not necessarily be a sign of trouble or even a sign that selling the stock is your best course of action. As with any financial decision, doing due diligence and careful research is key to successful investing. 

Examples of Dividend Cuts

Although most dividend-paying companies do everything they can not to slash them, there are cases when companies have no other alternative. The following are a few cases when companies decided to cut their dividends:

• Royal Caribbean Cruises: The cruise holding company suspended its quarterly dividend in 2008 as a cost-cutting measure. The aim was to improve the company’s profitability and liquidity.
• Wells Fargo: The bank cut its dividend by 85% in 2009 following the financial crisis. Originally 34 cents, Wells Fargo’s dividend dropped to five cents as a way to help cushion it from future losses.
• 3M: The company slashed its dividend after spinning off Solventum, its healthcare business. It adjusted its dividend payout ratio to 40% of adjusted free cash flow—a move that was expected by many experts.

Are Dividend Stocks Worth It?

This depends on your investment goals and financial situation. But, many investors like having dividend stocks in their portfolio. These companies offer a steady source of income and can help offset some of the risks associated with other investments in your portfolio.

What Is a Dividend Yield?

The term dividend yield refers to the dividend paid by a company expressed as a percentage of its share price. Put simply, it’s a financial metric that indicates a company’s dividend payout relative to its stock price. A company’s dividend yield is calculated by dividing the total annual dividends per share by the current share price.

What Is an Ex-Dividend Date?

An ex-dividend date is the date at which a shareholder becomes eligible to receive dividends. In simple terms, it is the cutoff date for dividend eligibility. This is typically one business day before the record date. Shareholders who purchase the stock before the ex-dividend date become eligible to receive the dividend. Those who begin investing in the stock on or after the date must wait until the next period to receive dividends.

The Bottom Line

Companies that can grow their dividends are seen as stable and attract investors looking for income as well as capital gains. Sometimes, however, it can hurt a company’s bottom line to distribute profits as dividends rather than retain earnings to solidify the company’s financials. Companies may cut dividends in response to an economic downturn, a spate of negative earnings, or more serious threats to the company’s health. Other times, the cut may be more strategic and orient towards future growth or allow for buybacks.

Fact checked by Kimberly Overcast
Reviewed by Akhilesh Ganti

Debt is not always a bad thing, especially in business. Debt provides liquidity to the financial markets by giving borrowers access to the capital they need. Individuals, businesses, and governments issue debt for a variety of reasons, trading the promise of repayment plus interest in the future in exchange for cash that is immediately accessible in the present.

Debt instruments come in different forms, some more obvious than others. Keep reading to find out more about debt instruments and the most common types issued by lenders.

Key Takeaways

• A debt instrument is an asset that individuals, companies, and governments use to raise capital or to generate investment income.
• Using debt instruments, investors provide fixed-income asset issuers with a lump sum in exchange for interest payments at regular intervals.
• Fixed-income issuers repay the full principal balance of a bond or debenture at the maturity date.
• Mortgages, loans, lines of credit, and credit cards are also considered debt instruments.

What Is a Debt Instrument?

A debt instrument is an asset that an entity uses to raise capital or to generate investment income. The basic premise is that the entity takes on debt to investors or lenders, which it will eventually have to repay, in return for immediate, liquid cash. Debt instruments can be used by individuals, businesses, or governments.

For instance, a company may need to finance the purchase of a new piece of equipment, while government agencies may require financing for projects such as infrastructure improvements or to fund their day-to-day operations.

This type of instrument essentially acts as an IOU between the issuer and the purchaser. The purchaser becomes the lender by providing a lump-sum payment to the issuer or borrower. In exchange, the issuing company guarantees the purchaser full repayment of the investment at a later date. The terms of these types of contracts often include the payment of interest over time, resulting in cumulative profit for the lender.

A vehicle that is classified as debt may be deemed a debt instrument. These can include traditional forms of debt including loans and credit cards, as well as fixed-income assets such as bonds and other securities. As noted above, the premise is that the borrower promises to pay the full balance back with interest over time.

Fixed-Income Assets

These assets are investment securities offered to investors by corporations and governments. Investors purchase the security for the full amount and receive interest or dividend payments over regular intervals until the instrument matures.

At this point, the issuer repays the investor the full principal amount invested. Bonds and debentures are among the most popular types of fixed-income debt instruments.

Bonds

Bonds are issued by governments or businesses. Investors pay the issuer the market value of the bond in exchange for guaranteed loan repayment and the promise of scheduled coupon payments. This is the annual rate of interest that a bond pays. It is generally expressed as a percentage of the bond’s face value.

This type of investment is backed by the assets of the issuing entity. If a company issues bonds to raise debt capital and declares bankruptcy, bondholders are entitled to repayment of their investments from the company’s assets.

Debentures

Debentures are often used to raise short-term capital to fund specific projects. This type of debt instrument is backed only by the credit and general trustworthiness of the issuer. Both bonds and debentures are popular among investors because of their guaranteed fixed rates of income. But there is a distinction between the two.

The primary difference between a debenture and other bonds is that the former has no asset backing it or collateral. The bondholders’ investment is expected to be repaid with the revenue those projects generate.

Important

Remember, if you invest in a debt instrument such as a bond, you become the lender. You become the borrower when you need capital, as is the case with a loan or credit card.

Other Types of Debt Instruments

Banks and other financial institutions also issue debt instruments. Most consumers, though, know these as credit facilities. Consumers apply for credit for a number of reasons, whether that’s to purchase a home or car, to pay off their debts, or so they can make large purchases and pay for them at a later date.

Banks use the money they receive from savers to lend out to others. Banks receive interest on top of the principal they lend out, a small portion of which is deposited into their clients’ savings accounts. These can be collateralized or not, depending on the type of facility and the borrower’s credit history.

Mortgages

These debt instruments are used to finance the purchase real estate. This could be a piece land, a home, or a commercial property. Mortgages are amortized over a certain period of time, allowing the borrower to make payments until the loan is paid off.

Lenders also receive interest over the life of the loan. The risk of default is reduced for the lender because mortgages are collateralized by the real estate itself. This means if the debtor stops paying, the lender can begin foreclosure proceedings to repossess the property and sell it to pay off the loan. The lender is free to pursue the borrower for any remaining balance.

Loans

Loans are possibly the most easily understood debt instrument. Most people use loans at some point in their lives. They can be acquired from financial institutions or individuals and can be used for a variety of purposes, such as the purchase of a vehicle, to finance a business venture, or to consolidate other debts into one.

Under the terms of a simple loan, the purchaser is allowed to borrow a given sum from the lender in exchange for repayment over a specified period of time. The purchaser agrees to repay the total amount of the loan, plus a pre-determined amount of interest in return.

Lines of Credit (LOC)

Lines of credit give borrowers access to a specific credit limit issued based on their relationship with a bank and their credit score. This limit is revolving, which means the debtor can draw on it regularly as long as they maintain their payments. Just like other credit facilities, borrowers pay principal and interest. LOCs may be secured or unsecured based on the needs and financial situation of the borrower.

Here’s an example of how they work. Let’s say Mr. C has a $20,000 LOC. He uses it to pay down some debt, buy some furniture, and pay a contractor for some work around his home. This totals $11,000. Mr. C still has $9,000 available. But if he makes a $5,000 payment to pay down his balance, he has access to $14,000 that he can use freely.

Credit Cards

A credit card provides a borrower with a set credit limit they can access continuously over time. Like a line of credit, consumers are able to use their credit cards as long as they make their payments.

Borrowers have two payment options:

1. Pay the balance in full each month and avoid paying any interest charges.
2. Make a smaller payment, down to the minimum monthly payment.

Paying less than the full balance on the card means the cardholder carries the remaining balance over to the next month. In most cases, this means a percentage of the remaining balance will be added as interest, which the cardholder also becomes responsible for paying off. The amount of interest added depends on the cardholder agreement.

Are Bonds a Smart Investment?

Bonds don’t have the same potential for long-term returns that stocks do, but they are more reliable. This is why they are often called fix-asset investments. Bonds don’t grow as quickly, so an entire portfolio invested in bonds will likely fall behind the rate of inflation. However, most portfolios will shift toward a greater allocation of bonds over time to minimize volatility as investors near retirement.

What Is a Consolidation Loan?

A consolidation loan allows you to reduce the number of debts and loans you are responsible for. When you take out a consolidation loan, you add up the amount you owe on other debts, then pay them back with the money you borrow from a single new loan. You are then responsible for paying off the new loan. This simplifies your monthly payments and may allow you to pay less in interest over time, depending on the terms of the loan.

What Is a Secured vs. Unsecured Loan?

A secured loan requires collateral, while an unsecured loan does not. Collateral is something you promise in exchange in you default on your loan. It is a form of assurance for the lender. For example, if you have a mortgage, the property you buy with the mortgage is your collateral. If you default on your mortgage, your mortgage lender can claim the property to repay your remaining debt.

The Bottom Line

Debt instruments allow the issuer to raise capital for a variety of reasons. They often come in the form of fixed-income assets such as bonds or debentures. In other parts of the financial industry, financial institutions issue them in the form of credit facilities.

In both cases, the borrower agrees to repay the lender the principal balance plus any interest by a certain date.

Fact checked by Ariel Courage
Reviewed by Khadija Khartit

Both intrinsic value and market value are ways of valuing a company. Both can be used by shareholders, new investors, or government agencies to understand the worth of a business. However, though they are theoretically measuring the same thing, the information they provide can have significant differences.

Market value is simpler to measure but strongly impacted by outside factors such as investor demand. Intrinsic value is harder to calculate but based on the fundamentals of a company, rather than on market sentiment.

Learn how each type of value is calculated and what it can tell you about a business.

Key Takeaways

• Intrinsic value and market value are two distinct ways to value a company.
• Market value is a measure of how much the market values the company, or how much it would cost to buy it.
• Market value is easy to determine for publicly traded companies but can be more complicated for private companies due to what information is available and accessible.
• Intrinsic value is an estimate of the actual value of a company based on its business fundamentals. it is separate from how the market values it.
• Value investors look for companies with higher intrinsic value than market value. They see this as a good investment opportunity.

Intrinsic Value vs. Market Value

Intrinsic value is an estimate of the value of a company based on its expected capacity to produce future free cash flows throughout its life. It is an internal value regardless of what the market sets as a value for it at a specific point in time.

Market value is the current value of a company as reflected by the company’s stock price. Therefore, market value may be significantly higher or lower than the intrinsic value. Market value is also commonly used to refer to the market capitalization of a publicly-traded company and is obtained by multiplying the number of its outstanding shares by the current share price. 

Important

Both market value and intrinsic value are easier to calculate for publicly traded companies than for companies that are privately held. This is because financial information, including financial statements and share price, are readily available for public companies but often difficult to find for private ones.

Intrinsic Value

Intrinsic value is a core metric used by value investors to analyze a company. The idea is that it is best to invest in companies that have a higher true value than the one being assigned to it by the market.

Intrinsic value is a type of fundamental analysis. Tangible and intangible factors are considered when setting the value, including:

• Financial statements
• Market analysis
• The company’s business plan
• Tangible assets, such as machinery or property
• Intangible assets, such as goodwill or brand recognition

There is an inherent degree of difficulty in arriving at a company’s intrinsic value. Due to all the possible variables involved, such as the value of the company’s intangible assets, estimates of the genuine value of a company can vary greatly between analysts. Another difficult factor in determining intrinsic value is how to value illiquid assets such as real estate and business lines.

Some analysts utilize discounted cash flow analysis to include future earnings in the calculation, while others look purely at the current liquidation value or book value as shown on the company’s most recent balance sheet. Other difficulties can come from the fact that the balance sheet is an internally produced company document and may not be a completely accurate representation of assets and liabilities.

Market Value

Market value is the company’s value calculated from its current stock price. It rarely reflects the actual current value of a company. Market value is, instead, more a measure of public sentiment about a company.

Market value reflects supply and demand in the investing market, indicating how eager (or not) investors are to participate in the company’s future. This can be impacted by a variety of factors such as:

• Positive or negative press about the company
• Positive or negative press about a competitor
• Public knowledge of the industry
• Opinions of board members, founders, or other public figures
• Global economic or political events

Because market value is strongly impacted by public opinion and external economic conditions, it is more likely to fluctuate than intrinsic value. A company with a high market value but a low intrinsic value is considered overvalued; one with a low market value but a high intrinsic value is considered undervalued.

Using Intrinsic vs. Market Value When Investing

The market value is usually higher than the intrinsic value if there is strong investment demand, leading to possible overvaluation. The opposite is true if there is weak investment demand, which can result in the undervaluation of the company.

For example, imagine a potential investor calculates Company A’s intrinsic value and finds that its shares should be trading at $50 per share. However, due to low demand in the market, they’re currently only trading at $25 per share. Company A’s intrinsic value is higher than its market value, which means the price per share is likely to rise. A value investor would be likely to buy shares of Company A because of the high potential for profit.

On the other hand, if Company B’s intrinsic value shows that its shares should be trading at $25 per share, but they’re currently trading at $50 per share, the company is likely overvalued. This could be due to a number of factors, such as negative press coverage of a competitor or being part of an industry that’s seen as “up and coming” regardless of the fundamentals of the company. A value investor would avoid buying shares of Company B because, if the market value were to move closer in line with the intrinsic value, they would lose money.

What Is a Value Investor?

A value investor is someone who looks for stocks that are trading at a lower price than they should based on a company’s intrinsic value or book value. These stocks are currently undervalued, which means they are likely to increase in price and make a profit for an investor.

Why Are Some Stocks Undervalued or Overvalued?

Stocks can become undervalued or overvalued for a number of reasons. Movements in the market can create herd mentality, when large numbers of people sell as a stock’s price is falling or buy as it is rising. Positive coverage of a company or its founders can cause its stock to rise in value, even if the fundamental value of a the company hasn’t changed. Negative coverage of a competitor or of the company’s overall industry can also cause a change in stock prices regardless of the value of the actual company.

What Is Used to Calculate a Company’s Intrinsic Value?

A company’s intrinsic value is often calculated using discounted cash flow (DCF) analysis. In this type of analysis, the company’s cash flows are estimated based on how the business may perform in the future. Those cash flows are then discounted to today’s value to obtain the company’s intrinsic value.

The Bottom Line

Intrinsic value and market value are both ways of valuing a company. Intrinsic value is a form of fundamental analysis that looks at a company’s underlying financials to determine its value. Market value uses what investors are willing to pay for a company to show its current value on the market.

Market value is easier to calculate, but it is impacted by external factors such as public opinion of the company or industry. Intrinsic value is more difficult to calculate but is a more accurate picture of the company’s worth. Both factors are used by value investors, who look for companies with a high intrinsic value but low market value to find investments that are likely to make a profit.

Fact checked by Betsy Petrick

If you’re trying to boost your credit score, you may be willing to try anything, including taking out a personal loan. It can work, but how much success you’ll have depends on your unique financial situation. The best prsonal loans can help establish a positive credit history, and they also help if you use the funds to pay off debt and keep it off. We’ll help you decide if this is the best course of action for you or if you should focus on other credit-building strategies.

Key Takeaways

• If you use a personal loan to pay down existing debt and you repay the loan, you might see your credit score improve.
• Taking out a personal loan and using the funds for purchases like a vacation, medical expenses, or big-ticket items can harm your score even more.
• To boost your credit score, you could focus on paying down existing debt, using a secured card, and becoming an authorized user on another person’s credit card.

Should You Use a Personal Loan to Build Credit?

A personal loan typically is unsecured and can be used for many reasons, such as a home renovation or a large purchase. Unlike a mortgage, you don’t always have to put down collateral to qualify.

Personal loans can be a useful credit-building tool, especially if you don’t have much credit history. Taking out a loan and paying it back on time and in full can do wonders for your score. Each payment you make is recorded with credit monitoring bureaus that look at various factors to determine your score.

Payment history accounts for 35% of your credit score and how much you owe makes up another 30%. So, whether you’re taking out the loan to establish a credit history or using the funds to pay off existing debt, responsible repayment of a personal loan can boost your score. Taking out a personal loan and paying it off shows lenders you can pay back money properly.

Pros

• Adds to your credit mix

• Consolidating debt can make it easier to manage

• Interest rates are fixed

• Can improve your score if you pay off outstanding debt

• Can help establish credit history

Cons

• Missing a payment can hurt your score

• Hidden fees and charges

• Higher interest rates for poor credit

• Easy to take out too big of a loan

Considering a Personal Loan? First, Ask Yourself These Questions

Personal loans may be right for some people, but for others, not so much. After all, you’re taking on substantial debt. If you miss payments or struggle to pay off the loan, your credit score will suffer. Before you apply for a personal loan, run through these questions to get an idea if personal loans are the right move for you:

• What is the interest rate?
• How much interest will you pay in total?
• Can you afford the monthly payments?
• Are there any fees and penalties?

Why you want to take out the loan is one of the biggest issues to consider. You won’t be able to take out a personal loan for things like education expenses, a down payment on a house, or investing, for instance.

Alternatives to Boost Your Credit Score

Taking out a personal loan to pay off your debt is tempting, but you have other credit-building options that don’t involve taking on more debt. Here are just a few:

• Ask someone to add you as an authorized user on their card: If your credit is poor or nonexistent, you might not qualify for a personal loan. If that’s the case, ask a trusted relative or friend to add you to their credit card as an authorized user. This helps you establish and build credit.
• Use a secured credit card: Instead of using an unsecured credit card, start using a secured one to avoid interest and overspending. To use a secured card, deposit money into the account. This becomes your card’s credit limit.
• Use less than 30% of your credit card limit: Credit monitoring bureaus look at how much debt you have in comparison to available credit. This is known as your credit utilization ratio. FICO recommends keeping your ratio under 30%.
• Always make your payments on time: Whether you’re paying your credit card bill, phone bill, or bill for streaming services, you should make a point of paying at least the minimum on time. Missed payments can cause your credit score to plummet.

Reviewed by Margaret James
Fact checked by Vikki Velasquez

If you’re an investor in real estate, especially in a large metropolitan area, you might have considered opening your rentals to Section 8 tenants. This federal program assists those with low incomes to find housing by subsidizing a portion of their monthly rent.

As a landlord, there are pros and cons to accepting housing vouchers. So, before you make the decision to do so, it’s wise to thoroughly research what to expect.

Key Takeaways

• Section 8 properties provide much-needed affordable housing to low-income families.
• Section 8 housing is nearly always in demand and may have long waiting lists. 
• Before purchasing property to use as Section 8 rentals, it is essential to be aware that the building must pass an inspection by the U.S. Department of Housing and Urban Development (HUD). 
• Landlords must follow strict HUD procedures when it comes to evicting tenants. 
• Families must meet eligibility guidelines to be awarded Section 8 housing.

What Is Section 8 Housing?

The Housing and Community Development Act of 1974 established the Housing Choice Voucher Program, which was an amendment to Section 8 of the Housing Act of 1937. This program assists low-income renters by providing vouchers that pay approximately 70% of their monthly rent and utilities.

Section 8 housing is overseen by the U.S. Department of Housing and Urban Development (HUD), and it is administered by public housing agencies (PHAs) in every state. PHAs determine Section 8 eligibility for their area based on income and family size.

In general, a family’s income must be below the 50% median income for their area to qualify for Section 8, but this can vary based on the city and the state. Because demand for Section 8 vouchers is so high in many areas, the waiting lists can be very long. Some families wait many years to receive assistance.

Note

Local PHAs may close their waiting lists—for example, in Los Angeles County, the waiting list was closed as of February 2025.

Once a family receives their Section 8 voucher, it is up to them to find a suitable property that accepts Section 8 tenants. Local PHAs normally have lists of such properties, while websites such as GoSection8 make it easy to search for rentals by zip code. The housing voucher generally covers 70% of standard rent for that area, with the family responsible for paying the remaining 30%.

Benefits of Section 8

Rent Is Paid on Time

One of the biggest perks of renting to Section 8 tenants is having 70% of your rent paid right on time each month. If you have struggled in the past to collect rent from tenants, you can count on partial payments on every unit.

Payments Are Deposited Monthly

The government will deposit your portion of the rent money right into your bank account on the same day each month.

No Shortage of Tenants

There is a huge need for affordable housing across the U.S. Waitlists for Section 8 properties are a testament to that fact, so you should have ample potential renters. Owning Section 8 property in an area where rentals tend to sit vacant for lengthy periods can be beneficial.

Challenges of Section 8

Extensive Property Inspections

Before you can accept renters, your property must pass an extensive inspection by HUD personnel. If your property is deemed insufficient, you have 30 days to make necessary corrections before being reinspected. After the initial inspection, your property will undergo repeated inspections, generally on an annual basis.

Rent Is Capped

The local PHA determines the fair market rent for your unit, which is the maximum you can charge. Plus, the rent cannot be more than 40% of a prospective tenant’s income. This often leads to Section 8 landlords charging their tenants less than they could a non-Section 8 tenant.

Evictions

While you are entitled to evict Section 8 tenants, you will need to follow HUD procedures to do so. HUD is usually more restrictive than the local eviction process. So if you are concerned about the potential of difficult evictions, this is something to consider.

How Do I Rent to Section 8 Tenants?

In order to rent to Section 8 tenants, you must apply for a permit from your local Public Housing Authority. This will require an inspection of your building. Once you are approved, you may start interviewing tenants who are planning to use housing choice vouchers to pay their rent.

Who Are Section 8 Tenants?

Section 8 tenants are individuals and families who meet the income thresholds to use housing choice vouchers to pay part of their rent.

Can Any Building Be Rented to Section 8 Tenants?

If you buy a building you plan to rent out to Section 8 tenants, you will need to make sure it meets all the local building codes and passes an inspection by your local Public Housing Authority.

The Bottom Line

Whether you are new to the world of real estate investment or an old hand, at some point you are likely to consider opening your property to Section 8 tenants. Before making the decision, it is prudent to arm yourself with knowledge of both the good and the bad about renting to this particular niche.

Only you, along with your property manager, can decide whether the pros outweigh the cons in your particular situation. If you do decide to move forward, it’s good to know that you’ll be providing safe housing to families who need it.

Fact checked by Marcus Reeves
Reviewed by Thomas J. Catalano

For investors seeking steady wealth-building rather than get-rich-quick schemes, dividend reinvestment plans (DRIPs) offer a methodical approach to growing investments over time. They come with built-in compounding that can greatly increase the size of your portfolio over the years and decades.

Many trading experts, including Yvan Byeajee, author of “Trading Composure: Mastering Your Mind for Trading Success,” argue that DRIPs can be a great part of a systematic approach that long-term investors need to succeed.

“Investing is about building wealth steadily over time. The key phrase is ‘over time,'” Byeajee told Investopedia. “Sustainable investing is about playing the long game, respecting the process, and allowing compounding to work its magic over time.” DRIPs embody this philosophy by automatically reinvesting cash dividends to buy additional shares of a company’s stock.

Key Takeaways

• Most investment experts and financial advisors suggest that most people benefit from a systematic, long-term way to build up their portfolios.
• A DRIP is one of these. It’s a dividend reinvestment plan through which cash dividends are reinvested to buy more stock.
• DRIPs use dollar-cost averaging (DCA), which is intended to average the price at which you buy stock as it moves up or down.
• DRIPs help investors accumulate additional shares at a lower cost since there are no commissions or brokerage fees.

Most major publicly traded companies like Johnson & Johnson (JNJ), The Coca-Cola Company (KO), and Procter & Gamble (PG) offer DRIPs either directly or through brokerage firms. These plans give investors a low-cost way to steadily increase their holdings without paying commissions or fees on reinvested dividends. DRIPs also help remove emotion from investing decisions since the reinvestment happens automatically, no matter the market conditions.

How DRIPs Work

A dividend is a reward to shareholders—often in the form of a cash payment via direct deposit. DRIPs allow investors the choice of reinvesting that cash in more shares of the company’s stock.

Many brokers allow you to reinvest dividends in the underlying securities through DRIP programs. However, you can also enroll in DRIPs directly with the company through direct stock purchase plans.

How Dollar-Cost Averaging (DCA) Works With DRIPs

“For most people in most situations, a long-term, buy-and-hold, diversified, low-cost investment approach is likely more suitable than active trading,” said David Tenerelli, a certified financial planner at Values Added Financial in Plano, Texas. “This is because it helps the investor ignore the ‘noise’ and instead focus on a disciplined approach.”

Tenerelli explained that one such strategy for long-term investing is dollar-cost averaging (DCA)—putting a set amount away periodically, no matter what. “It takes discipline to continue to buy investments during a market downturn, but a shift in mindset can help—rather than fearing financial loss, an investor can reframe it as buying stocks ‘on sale,'” he said.

DCA is a key feature of DRIPs. With DRIPs, your dividends automatically buy more shares when prices are low and fewer shares when prices are high. This means the dividends being reinvested are doing the work that most people with DCA strategies do by putting away a set amount of cash in an investment each pay period.

For example, suppose you receive a $100 quarterly dividend from a company. If the stock price is $50, your DRIP would buy two shares. But if the stock price drops to $25, that same $100 dividend would buy four shares. This automatic adjustment helps cut the risk of investing all your money when prices are at their peak and thus getting fewer shares in the long run.

Thus, the upshot of using DCA in DRIP programs is that it turns market volatility from your enemy into an ally, automatically buying more shares when prices dip.

Important

Experts like Byeajee and Tenerelli advise combining DCA with DRIPs because it removes more of the emotional element from investing. “It takes discipline to continue to buy investments during a market downturn,” Tenerelli said. “But a shift in mindset can help—rather than fearing financial loss, an investor can reframe it as buying stocks ‘on sale.'”

Types of DRIPs

Company-sponsored and brokerage-operated DRIPs offer different paths to reinvesting your dividends. Understanding the differences can help you choose the option that best fits your investment style and goals.

Company-Sponsored DRIPs

These let you buy stock directly from companies like Coca-Cola or Johnson & Johnson, often at a discount of 3% to 5% below market price, our review of such plans available online showed. DRIPs typically let you start with a small investment—sometimes buying even one share—and then make additional purchases over time.

Many companies go out of their way to make such plans seem like you’re joining a special club where you get special perks—which you do, including discounted shares and zero commission fees.

But why do companies do this? Simple: They get investment dollars or capital from shareholders, which they can use to reinvest and grow the company. In addition, investors who are part of a company’s DRIP program are believed to be less likely to sell their shares if the company has one bad earnings report or if the overall market declines.

Brokerage DRIPs

Brokerage DRIPs work differently. If you already have an account with Fidelity, Charles Schwab, etc., you can typically enroll any dividend-paying stocks you own in their DRIP program. While you won’t get the company discount, these plans offer more flexibility since you can easily manage all your investments in one place and quickly turn the DRIP feature on or off for different stocks.

Most investors start with brokerage DRIPs because they’re convenient and don’t require setting up separate accounts with each company. However, if you plan to invest regularly in a specific company over many years, a company-sponsored DRIP will save you more money in the long run.

The Benefits of Using DRIPs

Beyond automatic reinvestment, DRIPs offer several advantages that make them attractive for long-term investors. The most obvious benefit is the 3%-to-5% discount we mentioned above.

But DRIPs also help enforce investment discipline. When dividends are used to automatically buy more shares, you’re less likely to spend that money elsewhere.

Perhaps most importantly, DRIPs harness the power of compounding. Each reinvested dividend buys more shares, which then generate larger dividend payments, which then buy even more shares. Over time, this snowball effect can significantly increase your total returns.

Potential Drawbacks to DRIPs

While DRIPs offer many benefits, they’re not right for everyone.

Math With Fractions

Since dividends are typically less than the price of company shares, you’ll be buying fractional shares over time. For example, let’s say that Company X pays a $10 dividend on a stock that traded at $100 per share. Every time there’s a dividend, those within the DRIP plan would receive one-tenth of a share.

Since you’re buying fractional shares at different prices over time, calculating your cost basis for taxes can become complicated—imagine tracking hundreds of tiny purchases over many years. That said, whether you use a DRIP through the company or your brokerage, your DRIP account will likely take care of this, keeping detailed records of your share ownership percentages for you.

You’ll Need Patience

DRIPs also require patience and a long-term perspective. This is because, even if something comes up that requires you to sell your shares quickly, company-sponsored DRIPs can slow this process down since you typically must sell through the company rather than through a broker.

Diversification

In addition, too much of a focus on dividend-paying stocks might lead to a less diversified portfolio. Not all great companies pay dividends—for example, many growth stocks like technology companies reinvest their profits rather than paying dividends.

The problem becomes even more acute if you use company-sponsored DRIPs since you might limit yourself just to one or two companies, putting a far greater part of your portfolio in just one part of the market.

Tax Implications of DRIPs

Even though you’re reinvesting rather than receiving dividends in cash, the IRS still considers the dividends as taxable income in the year they’re paid out. Just like if you take your paycheck and put it right into a savings account, you still owe taxes on that income even if you never touch the money.

For regular dividend-paying stocks held in taxable accounts, these dividends are typically counted as qualified dividends, which are taxed at lower long-term capital gains rates rather than as ordinary income. However, you’ll need to meet certain holding period requirements to qualify for these lower rates.

In addition, when you eventually sell the DRIP shares, you’ll owe capital gains taxes on any appreciation in share value. This is where good record-keeping becomes crucial—you’ll need to know your cost basis (purchase price) for all those shares bought through your DRIP over the years.

Can I Participate in DRIPs If I Buy Stocks Through My Individual Retirement Account (IRA)?

Yes, you can enroll stocks held in IRAs and other retirement accounts in DRIPs. One advantage of reinvesting dividends in retirement accounts is that you won’t face any immediate tax consequences on the dividends, unlike in taxable accounts.

However, any dividends automatically reinvested still count toward your required minimum distributions once you reach the age when these become mandatory.

What Happens to My DRIP Investments If the Company is Acquired or Merges With Another?

There are a couple of possibilities. If the acquiring company has a DRIP, your enrollment might transfer to the new company’s plan. In cash buyouts, your DRIP typically ends and you receive cash for your shares. In stock-for-stock deals, your shares usually convert to the shares of the acquiring company. It’s important to read all communications from the company during these transitions since you may need to decide what happens to your DRIP account.

How Do Stock Splits Affect DRIPs?

When a company splits its stock, your DRIP should shift over seamlessly. For example, in a two-for-one split, you’ll now own twice as many shares at half the price, but the total value of your account will be the same.

Future dividend reinvestments will simply buy shares at the new split-adjusted prices. The main impact is that you might be able to buy more whole shares with each reinvestment since the share price is lower.

When Is a DRIP Not the Best Choice?

DRIPs might not suit investors who rely on dividends for income since reinvesting them takes away the cash you might need to be available. In addition, investors focused on maintaining a diversified portfolio may find DRIPs concentrate their investments too heavily on a single stock or handful of stocks. In these cases, manually reinvesting dividends in other securities might be more appropriate.

The Bottom Line

DRIPs offer a great way to build a portfolio over time, especially if you get a discount on the shares along with the effects of compounding. While DRIPS require patience and careful record-keeping, the potential long-term benefits often outweigh these challenges.

Just remember to consider both the advantages and limitations of these plans in the context of your overall investment strategy, risk tolerance, and tax situation.

Reviewed by Chip Stapleton
Fact checked by Vikki Velasquez

House flipping involves buying properties to renovate and resell quickly, and it requires more than just binge-watching HGTV and picking up a paintbrush. The real estate strategy generated median profits of about $73,500 per property in 2024—though novices are among those who consistently earned below that.

“As interest rates remain double what they were a few years ago and inflation keeps raising renovation costs, investors continue to have a tough time,” said Rob Barber, CEO of ATTOM, the real estate data analytics company. “It’s not as if profits have shot through the roof and investors are riding a new wave of good times. Far from it.”

This makes it all the more important that those flipping homes avoid the costly errors that can be ruinous for many in the mid-2020s. There are substantial risks many house-flipping shows skip over, from unexpected renovation costs to market downturns. Understanding these challenges—and how to avoid common pitfalls—can mean the difference between a profitable flip and a mistake so costly that it takes you out of the game entirely.

Key Takeaways

• Flipping is a real estate strategy that involves buying, renovating, and selling homes quickly for a profit.
• Novice real estate investors often underestimate the time and money a project will require.
• Another error that house flippers make is overestimating their skills and knowledge.
• Patience and good judgment are especially important in a timing-based business like real estate investing.
• Most successful flippers have either construction expertise or reliable relationships with contractors, since renovation costs can quickly eat up all the potential profits.

How Flipping Houses Works

Unlike traditional real estate investing where investors buy properties to rent them out, flippers aim to buy, renovate, and resell properties as quickly as possible to maximize profits and minimize holding costs.

Success in flipping comes from two main sources: market appreciation in rapidly growing neighborhoods and adding value through improvements to a property. For instance, a flipper might buy a dated home in an up-and-coming area for $300,000, spend $50,000 on strategic renovations, and sell it for $400,000—earning a $50,000 profit before accounting for holding costs and taxes.

However, every day a property sits unsold costs money in mortgage payments, utilities, property taxes, and insurance. This is why experienced flippers often focus on speed rather than squeezing out maximum profit. Carrying costs can quickly overtake potential profits.

The National Association of Realtors estimates the top 10 markets for home sales in the U.S. in 2025 will include four from the South: Boston-Cambridge-Newton, Massachusetts-New Hampshire; Charlotte-Concord-Gastonia, North Carolina-South Carolina; Grand Rapids-Kentwood, Michigan; Greenville-Anderson, South Carolina; Hartford-East-Hartford-Middletown, Connecticut; Indianapolis-Carmel-Anderson, Indiana; Kansas City, Missouri-Kansas; Knoxville, Tennessee; Phoenix-Mesa-Chandler, Arizona; and San Antonio-New Braunfels, Texas.

Where To Start

Successful flipping begins with getting a reasonable purchase price. Professional flippers often use the “70% rule”: Never pay more than 70% of a property’s after-repair value minus renovation costs.

For example, if a house is worth $300,000 after renovations and needs $50,000 in repairs, the maximum purchase price would be as follows:

$300,000 x 0.70 = $210,000 – $50,000 = $160,000

The formula builds in a margin for unexpected costs, market shifts, and profit. But you’ll need accurate estimates of both the after-repair value and renovation costs, and that takes skills that only come with experience and greater market knowledge.

Like any other small business, flipping requires time, money, planning, patience, skill, and effort. It will likely wind up being harder and more expensive than you ever imagined. Take it lightly at your peril. If you’re just looking to get rich quickly by flipping a home, you could end up in the poorhouse.

Below are the five mistakes to avoid if you get into the business of flipping homes.

1. Not Enough Money

Investing in real estate is expensive. The first and most obvious cost is the amount needed to buy the property. If you’re financing the acquisition, you’ll probably need to come up with a downpayment, and you’ll need to make mortgage payments, including interest. Interest on mortgages and home equity lines of credit (HELOCs) is deductible. The principal, taxes, and insurance portions of your payment are not.

Research your financing options to determine the best choice for your needs and to find the right lender. Use a mortgage calculator to compare rates that various lenders offer. Paying cash certainly eliminates the cost of interest, but even then, there are holding costs and opportunity costs for tying up your cash. In the flipping business, the sale price must be higher than the cost of acquisition, renovation costs, and holding costs combined.

Warning

Even if you manage to overcome the financial hurdles of flipping a house, don’t forget about capital gains taxes, which will take a chunk of your profit.

Making a profit is more challenging than before, as the median return on investment (ROI) in recent years has dipped under 30%, down from over 50% a decade ago. This doesn’t mean you can’t make money. It’s just that you’ll need to be more careful to ensure you do.

Important

Even if you get every detail right, changing market conditions could mean that every assumption you made at the beginning will be wrong by the end.

2. Not Enough Time

Flipping houses is time-consuming. It can take months to find the right property. Then you’ll need time to renovate, often the biggest time sink. Those with day jobs face a difficult choice: either sacrifice evenings and weekends to handle renovations personally or hire contractors and still spend significant time managing the project.

Even with contractors, investors must coordinate inspections, handle permits, and ensure work meets local building codes. If it doesn’t, you’ll need to spend more time and money to bring it up to par.

Selling the property also requires a great deal of time. If you show it to prospective buyers yourself, you may spend a good deal of time commuting to and from the property and in meetings. If you use a real estate agent, you’ll have to pay a commission.

For many, it might make more sense to stick with a day job, without taking on the financial risk and a major time commitment.

3. Not Enough Skill

Professional builders and skilled professionals, such as carpenters and plumbers, often flip houses to earn income on the side. They have the knowledge, skills, and experience. Some also have union jobs that may provide unemployment checks all winter long while they work on their side projects.

The real money in house flipping comes from sweat equity. So even if it’s not otherwise related to your employment, if you’re handy with a hammer, enjoy laying carpet, can hang drywall, roof a house, and install a kitchen sink, then you have important skills that save money when flipping a house.

But if you don’t know a Phillips-head screwdriver from a flat one, you will need to pay a professional to do the renovations and repairs. And that will cut the odds of making a substantial profit on your investment.

4. Not Enough Knowledge

You must know how to pick the right property, in the right location, at the right price. In a neighborhood of $400,000 homes, do you really expect to buy at $200,000 and sell at $300,000? That simply won’t happen regularly.

Even if you get the deal of a lifetime—for example, you snap up a house in foreclosure for a song—knowing which renovations to make and which to skip is key. You also need to understand the applicable tax laws and zoning laws and know when to cut your losses and get out before your project becomes a money pit.

Major lenders and private equity companies have also started to seek profits in the flip-loan marketplace, with global investment firm KKR joining other private investment firms seeking a piece of the action.

5. Not Enough Patience

Professionals take their time and wait for the right property. Novices rush out and buy the first house that they see. Then they hire the first contractor who makes a bid to address work that they can’t do themselves. Professionals either do the work themselves or rely on a network of prearranged, reliable contractors.

Novices hire real estate agents to help sell the house. Their commissions eat into profits (even after changes arising from the National Association of Realtors, which will eliminate advertising buyers’ agent commissions on the MLS). Many professionals sell the properties themselves to minimize costs and maximize profits. Novices expect to rush through the process, slap on a coat of paint, and earn a fortune. Professionals understand that buying and selling houses takes time and that the profit margins are sometimes slim.

Do I Need to Have a Cash Offer to Flip a House?

No. Cash can be more attractive to sellers, so you may see more cash offers accepted. Nationwide, about 63% of house flips are purchased with cash. However, that obviously leaves many people who do finance their house flips.

Which Cities Are the Best To Flip a House?

This depends a lot on what you’re looking for and your bankroll. But according to Merchants Mortgage, which provides capital to real estate investors, the best cities for house flipping in 2024 were Pittsburgh, Pennsylvania; Buffalo, New York; Baltimore, Maryland; and Oklahoma City, Oklahoma.

How Long Does It Take to Flip a House?

It generally takes four to six months from the purchase date to sell the finished home. However, the less experience you have, the more time it will likely take.

The Bottom Line

At any given time, at least a half-dozen shows are available to stream featuring amiable, well-dressed investors who make the flipping process look fast, fun, and profitable. But making a nice profit quickly by flipping a home is not as easy as these shows often make it appear.

Novice flippers can underestimate the time or money required and overestimate their skills and knowledge. If you are thinking about flipping a house, make sure you understand what it takes and the risks involved.