What are dividend reinvestment plans?

Three piggy banks in the sky

In my previous post, I listed three things you need to start investing. Number three was opportunities. Sometimes those opportunities are unique, one-off types of things; however, they can just as easily be something that's always been out there but you just weren't aware of them because you weren't paying attention to investing.

Let's explore one of those little-known opportunities — one that's legit, good, and yet often overlooked because it's a little, well, boring. It's name, DRIP, doesn't help either.

DRIP stands for Dividend Reinvestment Program. Simply put, participating companies (and there are hundreds) allow you to use the dividends you earn from them to buy stock directly from the company for little or no commission. (That's how you reinvest your dividends.)

Actually, it's not only the companies that offer DRIPs. DRIPs can be run by their stock transfer agents or brokerages. In my case, I use the Etrade's DRIP program. A DRIP is a set-it-and-forget-it kind of operation, so it doesn't matter too much who does it.

Related >> How to Get Started Investing

The DRIP Keeps Good Company

DRIPs share a unique corner of the investing space with a few other concepts. The cornerstone of this space is blue-chip stocks. Who hasn't heard of blue-chip stocks? But what exactly is a blue-chip stock? Can you name, say, five of them off the top of your head? Tricky, isn't it?

Here is arguably the best investment of all, and most of us simply don't know all that much about it! That's because there isn't a definitive list of the 23 or 57 stocks that make up the “official blue-chip list.”

The closest approximation, and the one probably used most often, is the Dividend Aristocrats. Most blue-chip stocks pay dividends. And only the cream can sustain growing their dividend each year for 25 years or more, through no less than three stock market crashes. (Where were you 25 years ago? That long.) Those few are the Dividend Aristocrats. At the time of writing, there are 51, listed here. Even when the stock market crashes, the dividends keep growing. And, with a DRIP in place, the only effect of a crash is you get more shares. And when the market recovers, like it always does, that puts you in the pound seats, as they say in the Colonies.

Most blue-chip (and other) companies offer a program called a DSPP, which stands for a Direct Stock Purchase Program. A DSPP allows you to buy a few shares from the company itself, not through a broker. That's right — if you want to invest $25 per month, for example, you can buy shares directly from blue-chip companies like Walmart, for way less in commissions than you would have paid a broker. Most companies' DRIPs are part of their DSPPs. While DSPP stock purchases typically carry a small fee, most companies do DRIPs for free.

So here's how all those concepts fit together: The safest stock investments (as a group) are the blue-chip companies called Dividend Aristocrats. If you sign up for their DSPP programs, you can buy into those companies with small amounts each month, for next to nothing in commissions/fees. And if you sign up for their DRIP, you can turn your cash dividends into more shares for no fees or commissions.

Why Do It?

1. You can save money

The low/no commission thing is not trivial. Most discount brokerages will do a purchase for nothing under about $7. If you want to invest, say, $50 a month, the commission alone will eat up 14 percent of your investment. Ghastly. Sign up with, say, Becton, Dickinson (amazing how unknown some blue-chip Dividend Aristocrats are, huh?) and they will charge you zero fees to buy with a DSPP or DRIP. They will charge you $15 per transaction when you sell, though. Almost all DSPP/DRIP companies are linked to Computershare, so that's a good place to get started. (Good news: They cover many countries besides the U.S.)

2. You can start small

Many people say they'll begin investing when they get windfalls. The smart ones, however, don't wait; they start early. Problem with that is the amounts they have to work with are usually small — young-people money. As I wrote earlier, that was my big problem (at least, that's what I told myself at the time). I would have been a lot better off had I known about DRIPs, because this is where they shine: you can invest as little as $25 per month. And if the company's stock is, say, $40 a share, they will sell you a fraction of a share — and pay dividends on that fraction! I'm an avid DRIPper, which is why I now have exactly 606.08274 shares of one of my DRIP stocks. That will change in a few weeks as the first quarter's dividends come in and add a few more shares (and a few more fractions) to that total.

3. It's automatic

All the smart personal finance coaches tell you to automate. Have the money deducted out of your account, preferably before you even know it's there. The human brain has an amazing knack to adjust to what's there. That's why most people who say they'll save “what's left over” never save anything. Most DSPP and/or DRIP plans require an automated, regularly recurring purchase in order to qualify for the low fees. That's because computers are cheaper than humans — if they can automate the whole thing, they save money and pass it on to you.

And the long-term benefit is all yours.

What Holds People Back?

1. Ignorance.

It's amazing how many people simply don't know about DRIPs.

2. It's not diversified.

Unlike a mutual fund or ETF, you only invest in one company at a time. However, you don't pay mutual fund or ETF fees, and you can buy smaller amounts that many of those places require. That means you get most of the benefits with none of the cost. Moreover, because you can buy small amounts at each company, you can make up a portfolio of, say, five to 10 companies.

3. It takes time to set up.

And no two companies' plans are identical. I opted for a brokerage DRIP because they did everything. All I had to do was say, “Yes, please.”

Where Do You Begin?

1. Decide if you even want to do this. DRIP investing is a long-haul thing. If you buy and sell stocks all the time, the savings won't be worth it for you. DRIPs are perfect for those want to let their dividends be part of the growth of the stock they invest in.

2. Research. Because you're picking a handful of companies, you want to spend at least 20 or 30 minutes looking at the company itself. Blue chips may be the best investment out there, but they're still not perfect. Nothing is. A little homework goes a long way.

Google the search terms DRIP, and Dividend Aristocrat, and browse through the Computershare website (link above).

In closing, I've been a DRIPper for quite a while now, and I can recommend it as a solid, long-term investment strategy to anyone. Those dividends come in, and the number of shares you own just grows and grows and grows.

What has your experience been with DRIP investing? Would you recommend it too?

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