This is a guest post from Sara, who writes about reaching for a life of greater simplicity and deeper meaning at On Simplicity.
I'm a simple girl and I love simple solutions. That's why I've fallen in love with DRIP investing — it's about as simple as investing gets. If you're an investor who likes to set it and forget it, DRIPs are a great weapon to have in your financial arsenal.
The term DRIP refers to “Dividend Reinvestment Program.” Don't let the term fool you, though, because DRIPs go way beyond dividends. Essentially, when you open a DRIP account with a company, they're letting you buy stock directly, cutting the brokerage firm out of the picture. This lets you buy additional stock with any dividends you earn, all without brokerage firms taking a bite of your profit.
The real beauty comes from the added perks of setting up a DRIP account. Many companies that offer DRIPs will also allow you to buy extra shares directly, again cutting out the middleman. Typically, you will need to set up a recurring transaction to get this benefit. In other words, you arrange to buy a certain dollar amount of stock each month (or quarter, depending on the company and plan you choose).
If this is all sounding a bit familiar, that's because it's not a new idea. Think of your 401(k): a little bit of money gets whisked away to buy shares of different funds each month. Do you miss that money? Probably not. Does it add up over time? You bet it does. The only difference with a DRIP is that you're building shares in a single company.
What Are the Benefits of DRIP Investing?
- Dollar cost averaging. Even though some people debate its benefits, there are some pretty strong arguments in favor of dollar cost averaging. You can minimize the effects of buying too low or too high, because you're buying in on a regular basis.
- Automated investing. Once you're signed up, you're good to go. You don't have to track the P/E, try to time the market, remember to place more orders, or even fuss with an online broker. DRIPs are hands-down the easiest way to invest in individual company holdings.
- Super-low transaction fees. You may get charged a fee for the annual DRIP service (or you may not). For instance, GE charges $12 a year. If you're set up for an automated stock purchase each month, that's $1 for a trade. Compared to traditional or online brokerages, that's a huge savings.
- Invest small amounts of money. You don't have to invest thousands at a time. Some programs let you invest as little as $10 per month. If you're not ready to invest a large amount, a DRIP account can help you build a solid position in a company over time with very small amounts.
What Are the Drawbacks?
- DRIPs are not diversified. The cold, hard truth is that you're investing in a single company, which always carries some risk. When you contribute to a mutual fund through your 401k each month, you're buying shares of many companies. If one tanks, you don't take a huge hit. When you invest your money in individual stocks, there's nowhere to spread the risk. DRIPs should always be part of a diversified portfolio.
- You're tying up a portion of your monthly income. If your budget is extremely tight, then going without that extra chunk of change can be difficult (but not impossible).
- Each company is different and requires a different sign-up process. The initial set-up can be a pain, as you may have to create an account with a third party transfer agent. They'll need all the traditional information a brokerage would need, so the process is a bit more involved than creating a user name and password. Once you've gone through the initial set-up, though, expect smooth sailing.
- The selection of available DRIPs is pretty small. This is actually a good thing, though, since DRIPs are ideally suited to blue chip companies that will be around for years to come. These companies, like P&G, AT&T, and GE are perfect for long-term investments, not quick profits.
How Do I Start?
- Research the companies that offer DRIPs. The list is growing regularly, so don't write off a company just because they aren't on someone's list.
- Research the heck out of any company you're considering investing in. Are they a good long-term investment? Do all the research you would normally do before any investment, and then do some more. You're making a long-term commitment to this company, so be sure it's a stock you're comfortable going on autopilot with.
- Contact the company (their website will usually have enough information to get started) and find out what you need to do to open an account.
- Jump through the necessary hoops, provide your bank account info (your money can be pulled directly from your account, just like online bill pay), and you're in.
A Word on Acronyms
You'll see DRIPs referred to in many different ways: DRP, DIP (Direct Investment Plans), SPP (Stock Purchase Plans) and OCP (Optional Cash Purchase Plan). Each of these different account types has slight variations, but the DRIP (or DRP) is at the heart of each, and that's why you'll see it being referenced most often, and why I've used that terminology here in an introduction-level piece.
Again, I'm a simple girl. I'm not claiming to be the expert on DRIPs, just a very satisfied user. As with any investment, you need to do your own research before diving in. For a more in-depth explanation of DRIP investing, check out the Motley Fool's take or MSN Money's explanation (the latter piece also does a great job of running the numbers on reinvestment). If you like simple solutions and are a long-term investor, DRIPs are worth a look.
Photo by Jaypeg21.