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.
What Is a DRIP?
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.
This article was written by Sara, who writes about reaching for a life of greater simplicity and deeper meaning at On Simplicity.
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There are 43 comments to "Simplify your investing: An introduction to DRIPs".
Eric J. Nisall says23 July 2008 at 05:07
Excellent post, Sara and J.D. I am a firm believer in investing for the long-term, and invest a healthy portion of my retirement savings in high-yielding stocks with a long history of increasing dividend payouts year-over-year. My preference happens to be to invest through my brokerage account at E*Trade, where dividend reinvestment is free, so all I have to do is make a single purchase, and elect to have the dividends automatically reinvested. This way, I only have to make the initial expenditure of $9.99 for the trade and never pay another penny to reinvest nor to commit to continued purchases in order to reap the benefits of both dollar-cost-averaging as well as compounding.
A good site to check out is http://www.dividendachievers.com as it is run by Mergent who has a long history of researching companies which continue to increase dividends and compiling categorical listings which aid in the research of such firms. They run several ETFs and funds and also publish books quarterly filled with data which make it fairly easy to narrow down which stocks you may be interested in researching before making a final decision of which ones to invest in (since everyone should do their own research before making a purchase).
Great post. I think that every person needs to make sure that the way he chooses to invest his money is the way that suits him best.
Good research can be very helpful, but smarts are important, too, because in the long run, it will bring you maximum profit.
Kristen a.k.a. The Frugal Girl says23 July 2008 at 05:30
Good to know…I’m sort of an investing idiot, so simple appeals to me!
I wonder if this might be a good, simple way to teach investing to my kids as they get a bit older. I’d like for them to turn out to be not so clueless about investing as I am!
This is only a strategy for investing. If you are interested in teaching your children the basics to give them a foundation for investing, your best bet may be to take a look at J.D.s book section and make a visit to your local library or bookstore. You may even want to see if there are beginner classes at the local high school or university that you may sign up for yourself, that way you will already have that foundation and be able to provide even more assistance to them as they begin their journey.
This is really interesting. I know the company I work for offers this but only to employees. Is there anyway you could create a short list of companies (other than the ones already listed) that offer DRIPs? Thanks.
KF, the list of companies offering DRIPs is too long to be considered short. 🙂
However, I did find an online tool that lets you screen for companies. Try DRIP Wizard. I haven’t used it myself (and it looks a little clunky), but it may help you find places to invest.
I think a better way to go about it would be to think about which companies you are interest in investing in and going to their individual websites. Under the investor relations sections there will be a link to the administrator of the DRIP (if there is one) that will contain all of the pertinent information.
I am sorry but single stock investing is a horrible idea for an individual investor, remember Enron, WorldCom, and currently anyone who owns bank stocks? You are far better off going the route of a sharebuilder or something like that to buy an broad market index fund or even better a small diversified portfolio.
For people in Canada there is an discount online broker called ShareOwner Investments. They offer free DRIPs and some great transaction costs for people doing low transaction counts.
Their commission structure is 9 bucks a trade for the first 4 stocks in an order, and then free after that. So if you want to save money in a savings account and once a year buy 10 of your favorite dividend payers the transaction will be 36 bucks. All dividends paid are automatically used to purchase more shares with no transaction costs.
They have some drawbacks, as they are a co-op trading company they only do purchases at certain times, they pre-screen a list of securities you can purchase from (since it’s a co-op) so you have a list of about 200 or so things to pick from.
For the yearly purchaser of dividend payers in Canada however, they seem to offer about the perfect purchasing setup. If you want the freedom to buy and sell on a whim and access to anything then a different broker would be better.
I agree with Seth. For most people single stock investing is not smart. You are much better off to invest in index mutual funds or ETF’s. You can also automatically invest each month and most index funds have a vety low expense ratio compared to an active mutual fund. Education is the key to investing.
“SOME”?? Are you kidding me? We are talking about a devastatingly high amount of risk. Typical DRIP investors are not very sophisticated, and don’t have big portfolios. Typically they also have other ties to the company they buy shares of (employees, relatives of employees, suppliers, etc.), which means that if the company goes south they are exposed to a double whammy.
Thanks to everyone for taking the time to comment. Like others have noted, investing in a single company is a risk–that’s really the bottom line.
Still, for me, it’s been worthwhile to invest in a handful of single companies as part of our overall portfolio. We can’t predict the Enrons, but I don’t think that discounts all blue chip companies, which are often part of funds anyway.
Again, it’s up to each investor to decide what’s right for their goals and risk tolerance level.
Seth and No Money key up on an important point. Unless you are a sophisticated investor who knows how to properly value a company, single stock investing IS risky for the average investor. To say that a Blue Chip is less risky, like a GE or AT&T is a misnomer. While it’s true that many “Blue Chips” do stay in business for many years, it is precisely because of their size that increases your risk exposure. To grow 10% a company that earns 1 million only has to make 100k more the following year. A company that earns 20 billion must find a 200 million to sustain 10% growth. I’m not saying there are companies out their that are large and can sustain that level of growth, what I’m saying is you need to be savvy enough to know the difference. Otherwise stick with a well diversified portfolio like the two others recommend.
One thing to keep in mind is the tax implications of this kind of program. I think companies are now required to do most of the record keeping for you, but I recently sold some 20 year old stock that had had all the dividends reinvested (that a relative purchased in my name when I was a kid) and getting the cost basis was a royal pain – it was a small company that wasn’t exchange listed at the beginning and had been bought out, and the purchasing company didn’t even have records of the old stock prices. Not likely to be an issue for IBM, but you’ll still likely have a mix of short and long term capital gains when you sell.
Do any mutual funds waive or reduce transaction fees if you buy a bit every month or quarter? A DRIP-type plan with mutual funds seems like a better bet for most individual investors.
This article was very informative. Wile DRIPs seem really interesting, the fact that they are not diversified would make me steer clear of them. Have you thought about ETFs? There are many benefits to investing in them. Here is a link to some pros and cons of these funds. http://www.etfmarketpro.com/Pros-and-Cons-of-ETFs.html
JD, can we have a series about investment methods that are not commonly discussed?
Jessica, can you give me examples of “investment methods not commonly discussed”? It sounds like a good idea.
Everyone else, I think Sara would agree (inasmuch as she states it in her article) that diversification is very important. I personally would never advice only carrying a portfolio of DRIPs. But as part of a more sophisticated asset allocation, I think this is a great way to invest in individual companies. If that’s your thing. (It’s no longer my thing. I’m an index fund man right now!)
Another thing to keep in mind (at least for Americans) when starting DRiPs is selling the stocks. I know, I know – the point is to accumulate stock not sell it, however after many, many years most investors sell stock.
However when you sell the stock the capital gains must be reported to the IRS. Capital gains on stocks are the difference between purchase and sale price times the number of shares held. Simple enough, unless you buy stock 4 or even 12 times a year for 20 years.
The other big benefit of DRIP is the compounding benfits of those reinvestments. If you really want to reduce the tax implications of DRIP – use it in your Roth IRA (see my recent post on this). Use a fund or ETF in your Roth IRA and ensure the dividends are reinvested. This way you get all the benefits mentioned in this article, without the tax hit.
Early Retirement Extreme says23 July 2008 at 09:54
More advantages: DRIP companies sometimes offer a discount on reinvested dividends e.g. they’ll sell you the shares for 5% off market.
More disadvantages: The IRS .. figuring out the cost basis for hundreds of small transactions can be a nightmare in book keeping. Of courses this is as much a issue for anyone who buys one share here one share there.
There are programs that can do that, but you have to use them from the beginning. Presumably if you stick it in a Roth, this will not be an issue.
Some comments:
I don’t think there such as thing as buying too low ;-P
If you have 10-15 drips or stocks in different sectors, you’re about as diversified as an index fund. Except you don’t have any expenses which admittedly are low for most index funds but still not 0.
Dividend Growth Investor says23 July 2008 at 10:08
First of all thanks Sara for writing this nice informative article and thanks JD for hosting this article.
I do believe that reinvesting your dividends is very important, since dividends have accounted for over 40% of stock market returns over time. Re-investing does help you compound your investment faster.
Check out this graph for performance of dividend paying vs non-dividend paying stocks:
I agree that investing in single stocks is risky indeed. That’s why one needs to hold at least 30-50 individual stocks in their portfolio or several ETF’s in addition to having some fixed income exposure.
One of the problems with DRIP’s is that the income from dividends that you used to buy more stock is indeed taxable, even though you didn’t get to enjoy it. In addition to that, it could be complicated to hold 30-50 drips in order to be diversified.
That’s why I believe that the best way to take advantage of dividend investing is by opening a brokerage account with a broker like Sharebuilder, which allows you to re-invest your dividends for free for thousands of US stocks. In addition, for a small annual fee, you could also open a retirement account with a broker that lets you re-invest your dividends without having to pay taxes on the income, untill you reach retirement age.
One last thing about DRIP’s is that there are several companies out there which allow investors to purchase shares at a 2%-10% discount to their price when you reinvest your dividends. Examples include ACAS and NNN.
And last but not least a small investment in a dividend stock that you let to compound for at least 2-3 decades will bring in about the same amount of income as your initial investment. For proof of this on SPY check out this:
Thank you for this article. I like having the advantages and disadvantages of DRIPs laid out for me.
Since DRIPs are not diversified when investing in one company, it seems logical that someone would choose to invest in more than one over time. Alternatively, they would be sure to invest in a wide range of companies to diversify their investments (even if they don’t use a DRIP for subsequent investment choices).
Hi Sara: Excellent post! What usually gets to me is how people seem to think that they have to have lots of money to be able to start investing in the stock market, and you’ve shown here why that’s just wrong. I read a report once on how to become a millionaire by investing just one dollar a day. Of course, it takes many years, but it goes to show that even if you have a small income, if you start investing early you can retire a millionaire.
If you have a brokerage account, such as TDAmeritrade, Etrade or whatever, as long as the stock or fund allows it, you can set up all your dividends to reinvest. This is no secret and it is normally a simple point and click process. You do not have to look for ‘special companies that allow DRIPs.’
Furthermore, if you have funds within an IRA you should be able to do the same… All teh retirement programs I have belonged to in the past have allowed this.
All programs are not the same. I got rid of TD Ameritrade because they did not have an automated system for this (I don’t know if that has changed). I had to call them to find out which companies they supported which really annoyed me, I have to admit. However, with E*Trade, it is like you stated, just select which stock you want registered for the DRIP, and you’re done.
Great post! Here’s my positive story about DRIPs. I had a friend/co-worker who was an investor of sorts. Right after we had our son, he told me about a DRIP he participated in. It was one with the local power company, which is also one of the largest utilities in the nation. You could start out with a minimum of $25/mo. So we started one for ourselves and our son at that amount. At the time, we started (20 years ago) it was by checks with “coupons.” Later it was by automatic deduction. Each year we increased it slightly. I believe the most we ever did per month was $100 for each account during the last few years of using the DRIP (prior to that we did $40, $50, and $75 … very manageable amounts). By the time our son was 12, his account had well over $20,000 in it. We took $14K of the money and did a lump sump purchase of a tuition reimbursement plan for him. This was such a relief to have that money ready to go and not to have worry about loans, paying huge monthly fees, etc. Shortly thereafter the cost of these plans went way up so the timing was also beneficial. He’s finished two years of college and the actual funds we contributed are almost gone (they show you that in case the student withdraws from college and you want to cash in on the value of your account). We stopped contributing to the DRIPs about the time we purchased the tuition reimbursement plan and started investing more heavily in our 401Ks. However, since then we have continued to use the account to fund scholarly travel for our son (e.g., global young leaders conference). There is still a small amount of money in his account. Likewise, we have used our own account to fund different projects throughout the years. It was such an incredibly effortless way to invest and more importantly to us, like Sara stated, it was simple. We didn’t feel like we needed a financial or investment background to use this method and all it required was a reasonable payment/investment monthly. Granted it is important to pick a company that has a proven track record. And, also I agree with the person who said it is a pain to figure our the cost basis for tax purposes. However, that minor annoyance at tax time is worth it. I highly recommend this method if you do your research, which in our case included the recommendation of this friend who had no vested interest in us using the DRIP.
Company Sponsored DRIPs are a useful way to invest in individual companies for those with smaller amounts. I have invested through them for years and have had mixed results.
I would probably recommend folks focus on opening a low cost brokerage account so they can have access to any stock vs trying to open up several accounts to invest in a couple companies. However, if your interest is to invest in a particular company with small amount of money – these can be the lowest cost way to do it – a great tool for kids.
I thought I read somewhere that DRIPs could really result in a tax headache due to the large number of transactions, rather than large sums of money going in at regular intervals. Anyone know if this is true or debunkable?
Coming at this from the perspective of a young investor starting out, I’m on track to start a dividend-growth portfolio with a long-term goal, but I’m using a discount broker, not DRIPs. It should simplify the tax accounting, and crucially I can afford to invest enough to make the commissions worth it. The prospect of eventually managing more than a dozen DRIPs, each with its own fees & policies, possibly dealing with checks in the mail & address changes… no thanks.
I’m not averse to securities research, and sticking to dividend-growth companies narrows the field quite a lot. That said, the Mergent handbook for 2007 contains many banks… I wouldn’t sink my retirement money in this. An attractive alternative is Vanguard’s STAR fund, which only requires an initial $1000 investment and $100 for additional contributions for individual non-retirement accounts.
Laurie | Express Yourself to Success says24 July 2008 at 06:06
Thanks for the information, Sara and J.D. I’ve never been introduced to this kind of investing before and I appreciate your bringing attention to it. I’ll be checking it out.
As a tax preparer I agree with what everyone said before, they are an absolute pain to track the basis of when you sell the company. Unless you do so perfectly you’ll probably ending up overpaying your taxes on these. Mutual funds are similar where people will know how much they spent initally but not how much has been purchased with their dividends, thereby not having a high enough cost basis when they sell and overpaying on taxes.
I think DRIPS were a good idea initially when they first came out, but now discount brokers and technology have replaced their former great benefits by making them obsolete and a bigger hassle then they’re worth. Who really wants to safeguard the actual stock certificates of a company they buy? Much less finding someone to buy your physical stock certificates.
Personally, I like to let my dividends just go into my basic brokerage account, then when I do my monthly investing I’ll use the dividend money to buy whatever investment I need to keep my portfolio diversified, instead of accumulating more of the same asset.
I can attest that drips work to add to your bottom line I am just an ordinary guy who reads everything i can on stock investent.I invested $1175 in my electric utility (a monopoly in my island), then followed up that with $125 per month .That time was may 1990. Today i have a small but important $87,565. This has led me to other drips such as Proctor and Gamble, Mcdonalds, GE, Exxon, Texaco, Coca Cola ,Altria Group and Pepsi.
I totlally disagree with those saying no to drips.
Those who state go sharebuilder miss the concept.
I have been doing drips for 15 years and simultaniously doing the same investings in a brokerage account.
And only 8 stocks (started with 3)..
Btw, my non-brokerage drips have nearly $50k more in them combined than I do with the brokerage.
And the brokerage was cheap to do to drip similar with them… Nearly as cheap as sharebuilder.
Fact is, drips are a paperwork nightmare but only if you dont document it when u get it… its easy with sw to do that.
Also, for some the hard part is selling it.
For others its easy.
I have in fact sold one the drips per a serious heart related deal.
Ie; once you need the $$ the drip is no longer. Though Im young enoguh still to consider restarting that one.
First off, when you do real drips, you own the stock directly.
When you buy it via any broker, you dont truely own it, but do via the brokerage.
Difference, with real drip you can go anywhere to cash the drip based stocks and in soem cases even sell it at market back to the company itself.
Though taking a ‘real’ drip and thenmoving it to IRA or brokerage,can be a costly deal.
Since it is easy to sell and or go ‘drip IRA’ its better to do it that way.
DRIP IRA’s are a bit hard to manage though I dont do them.
Also, like any other investement there are drips to stay away from.
I for one, will never as a rule go for a drip that has any fees of any kind.
There are a huge amt of ones with no costs.
The only costs I ever have is the initial setup cost ($25) and the initial share requirements), once thats done…Only the peridioic buy each month or quarter is it.
There are some really good drips that have various fees (I have only 1) that can be worth it. In those cases the cost was worth it till this year (per crash).
Wow, interesting to see so much interest in DRIPs here. I’ve written quite a bit about it, I’ve been a DRIP investor for about 10 years now, but I think I avoid many of the pitfalls mentioned above, or they’re not that relevant. Online accounts with registrars take care of all your tax forms and paperwork. So that’s no big deal. And as for risk in a single company? Not so much if you do your homework. Just because a company has a DRIP doesn’t mean it’s a great investment. I know most people don’t have the time or energy to do as much research as might be required, so for them perhaps an ETF is better (assuming they can avoid the commissions by investing huge amounts at once, of course).
DRIPs are not all of my portfolio, but they definitely got me off to a great start.
hey Sara,
I’ve been doing DRIPs for years. Simple is good, and simple and automatic is even better. Of course, DRIPs should not be the only investment strategy a person uses, but they can be part of it. I also think there are solid reliable companies out there that one can trust for a part of their portfolio. Go DRIP! ~ Justin Show
I’m trying to get my daughter to begin investing and she doesn’t have the money to pay a brokerage fee every time she wants to invest $10 – $50. In this case, a DRIP could be better than nothing, presuming she will eventually work for a company with a 401K and diversify her portfolio. As for investing heavily in one company, millions of people do just that when they put a large chunk of their money into the company they work for via their 401K rather than mutual funds. It really depends on the company, my coworkers at Chevron have done fabulous over the years, but Enron employees not so much. I think the main thing to keep in mind is that this is for those that can’t afford $7 – $10 fee every time they want to invest a small amount and maybe don’t have the discipline to invest unless it’s automatic.
There are 43 comments to "Simplify your investing: An introduction to DRIPs".
Excellent post, Sara and J.D. I am a firm believer in investing for the long-term, and invest a healthy portion of my retirement savings in high-yielding stocks with a long history of increasing dividend payouts year-over-year. My preference happens to be to invest through my brokerage account at E*Trade, where dividend reinvestment is free, so all I have to do is make a single purchase, and elect to have the dividends automatically reinvested. This way, I only have to make the initial expenditure of $9.99 for the trade and never pay another penny to reinvest nor to commit to continued purchases in order to reap the benefits of both dollar-cost-averaging as well as compounding.
A good site to check out is http://www.dividendachievers.com as it is run by Mergent who has a long history of researching companies which continue to increase dividends and compiling categorical listings which aid in the research of such firms. They run several ETFs and funds and also publish books quarterly filled with data which make it fairly easy to narrow down which stocks you may be interested in researching before making a final decision of which ones to invest in (since everyone should do their own research before making a purchase).
Great post. I think that every person needs to make sure that the way he chooses to invest his money is the way that suits him best.
Good research can be very helpful, but smarts are important, too, because in the long run, it will bring you maximum profit.
Good to know…I’m sort of an investing idiot, so simple appeals to me!
I wonder if this might be a good, simple way to teach investing to my kids as they get a bit older. I’d like for them to turn out to be not so clueless about investing as I am!
@ Kristen
This is only a strategy for investing. If you are interested in teaching your children the basics to give them a foundation for investing, your best bet may be to take a look at J.D.s book section and make a visit to your local library or bookstore. You may even want to see if there are beginner classes at the local high school or university that you may sign up for yourself, that way you will already have that foundation and be able to provide even more assistance to them as they begin their journey.
This is really interesting. I know the company I work for offers this but only to employees. Is there anyway you could create a short list of companies (other than the ones already listed) that offer DRIPs? Thanks.
KF, the list of companies offering DRIPs is too long to be considered short. 🙂
However, I did find an online tool that lets you screen for companies. Try DRIP Wizard. I haven’t used it myself (and it looks a little clunky), but it may help you find places to invest.
I think a better way to go about it would be to think about which companies you are interest in investing in and going to their individual websites. Under the investor relations sections there will be a link to the administrator of the DRIP (if there is one) that will contain all of the pertinent information.
I am sorry but single stock investing is a horrible idea for an individual investor, remember Enron, WorldCom, and currently anyone who owns bank stocks? You are far better off going the route of a sharebuilder or something like that to buy an broad market index fund or even better a small diversified portfolio.
For people in Canada there is an discount online broker called ShareOwner Investments. They offer free DRIPs and some great transaction costs for people doing low transaction counts.
Their commission structure is 9 bucks a trade for the first 4 stocks in an order, and then free after that. So if you want to save money in a savings account and once a year buy 10 of your favorite dividend payers the transaction will be 36 bucks. All dividends paid are automatically used to purchase more shares with no transaction costs.
They have some drawbacks, as they are a co-op trading company they only do purchases at certain times, they pre-screen a list of securities you can purchase from (since it’s a co-op) so you have a list of about 200 or so things to pick from.
For the yearly purchaser of dividend payers in Canada however, they seem to offer about the perfect purchasing setup. If you want the freedom to buy and sell on a whim and access to anything then a different broker would be better.
I agree with Seth. For most people single stock investing is not smart. You are much better off to invest in index mutual funds or ETF’s. You can also automatically invest each month and most index funds have a vety low expense ratio compared to an active mutual fund. Education is the key to investing.
“…which always carries some risk…”
“SOME”?? Are you kidding me? We are talking about a devastatingly high amount of risk. Typical DRIP investors are not very sophisticated, and don’t have big portfolios. Typically they also have other ties to the company they buy shares of (employees, relatives of employees, suppliers, etc.), which means that if the company goes south they are exposed to a double whammy.
Thanks to everyone for taking the time to comment. Like others have noted, investing in a single company is a risk–that’s really the bottom line.
Still, for me, it’s been worthwhile to invest in a handful of single companies as part of our overall portfolio. We can’t predict the Enrons, but I don’t think that discounts all blue chip companies, which are often part of funds anyway.
Again, it’s up to each investor to decide what’s right for their goals and risk tolerance level.
Etrade offers to set up drip accounts for your dividends automatically.
Seth and No Money key up on an important point. Unless you are a sophisticated investor who knows how to properly value a company, single stock investing IS risky for the average investor. To say that a Blue Chip is less risky, like a GE or AT&T is a misnomer. While it’s true that many “Blue Chips” do stay in business for many years, it is precisely because of their size that increases your risk exposure. To grow 10% a company that earns 1 million only has to make 100k more the following year. A company that earns 20 billion must find a 200 million to sustain 10% growth. I’m not saying there are companies out their that are large and can sustain that level of growth, what I’m saying is you need to be savvy enough to know the difference. Otherwise stick with a well diversified portfolio like the two others recommend.
One thing to keep in mind is the tax implications of this kind of program. I think companies are now required to do most of the record keeping for you, but I recently sold some 20 year old stock that had had all the dividends reinvested (that a relative purchased in my name when I was a kid) and getting the cost basis was a royal pain – it was a small company that wasn’t exchange listed at the beginning and had been bought out, and the purchasing company didn’t even have records of the old stock prices. Not likely to be an issue for IBM, but you’ll still likely have a mix of short and long term capital gains when you sell.
Do any mutual funds waive or reduce transaction fees if you buy a bit every month or quarter? A DRIP-type plan with mutual funds seems like a better bet for most individual investors.
This article was very informative. Wile DRIPs seem really interesting, the fact that they are not diversified would make me steer clear of them. Have you thought about ETFs? There are many benefits to investing in them. Here is a link to some pros and cons of these funds.
http://www.etfmarketpro.com/Pros-and-Cons-of-ETFs.html
JD, can we have a series about investment methods that are not commonly discussed?
I’d prefer to do an Index Fund. I really don’t like the idea of being required to put my eggs in one basket.
I can’t think of a single major investor who advises casual investors to buy single companies. Ever. In the history of investing.
Jessica, can you give me examples of “investment methods not commonly discussed”? It sounds like a good idea.
Everyone else, I think Sara would agree (inasmuch as she states it in her article) that diversification is very important. I personally would never advice only carrying a portfolio of DRIPs. But as part of a more sophisticated asset allocation, I think this is a great way to invest in individual companies. If that’s your thing. (It’s no longer my thing. I’m an index fund man right now!)
Also, DRIP programs can slightly complicate your cost basis and consequently your tax consequences.
Another thing to keep in mind (at least for Americans) when starting DRiPs is selling the stocks. I know, I know – the point is to accumulate stock not sell it, however after many, many years most investors sell stock.
However when you sell the stock the capital gains must be reported to the IRS. Capital gains on stocks are the difference between purchase and sale price times the number of shares held. Simple enough, unless you buy stock 4 or even 12 times a year for 20 years.
The other big benefit of DRIP is the compounding benfits of those reinvestments. If you really want to reduce the tax implications of DRIP – use it in your Roth IRA (see my recent post on this). Use a fund or ETF in your Roth IRA and ensure the dividends are reinvested. This way you get all the benefits mentioned in this article, without the tax hit.
More advantages: DRIP companies sometimes offer a discount on reinvested dividends e.g. they’ll sell you the shares for 5% off market.
More disadvantages: The IRS .. figuring out the cost basis for hundreds of small transactions can be a nightmare in book keeping. Of courses this is as much a issue for anyone who buys one share here one share there.
There are programs that can do that, but you have to use them from the beginning. Presumably if you stick it in a Roth, this will not be an issue.
Some comments:
I don’t think there such as thing as buying too low ;-P
If you have 10-15 drips or stocks in different sectors, you’re about as diversified as an index fund. Except you don’t have any expenses which admittedly are low for most index funds but still not 0.
First of all thanks Sara for writing this nice informative article and thanks JD for hosting this article.
I do believe that reinvesting your dividends is very important, since dividends have accounted for over 40% of stock market returns over time. Re-investing does help you compound your investment faster.
Check out this graph for performance of dividend paying vs non-dividend paying stocks:
http://dividendgrowth.blogspot.com/2008/06/when-to-sell-your-dividend-stocks-part.html
I agree that investing in single stocks is risky indeed. That’s why one needs to hold at least 30-50 individual stocks in their portfolio or several ETF’s in addition to having some fixed income exposure.
One of the problems with DRIP’s is that the income from dividends that you used to buy more stock is indeed taxable, even though you didn’t get to enjoy it. In addition to that, it could be complicated to hold 30-50 drips in order to be diversified.
That’s why I believe that the best way to take advantage of dividend investing is by opening a brokerage account with a broker like Sharebuilder, which allows you to re-invest your dividends for free for thousands of US stocks. In addition, for a small annual fee, you could also open a retirement account with a broker that lets you re-invest your dividends without having to pay taxes on the income, untill you reach retirement age.
One last thing about DRIP’s is that there are several companies out there which allow investors to purchase shares at a 2%-10% discount to their price when you reinvest your dividends. Examples include ACAS and NNN.
And last but not least a small investment in a dividend stock that you let to compound for at least 2-3 decades will bring in about the same amount of income as your initial investment. For proof of this on SPY check out this:
http://dividendgrowth.blogspot.com/2008/04/back-test-results-of-one-rule-of-thumb.html
Dividend investing is one of the few methods that could create truly passive income once they are st up.
Thank you for this article. I like having the advantages and disadvantages of DRIPs laid out for me.
Since DRIPs are not diversified when investing in one company, it seems logical that someone would choose to invest in more than one over time. Alternatively, they would be sure to invest in a wide range of companies to diversify their investments (even if they don’t use a DRIP for subsequent investment choices).
I found this little bit about DRIPs for children that might be useful to some:
http://www.dolans.com/straight_talk_tip/dividend_reinvestment_plan_77.html
Hi Sara: Excellent post! What usually gets to me is how people seem to think that they have to have lots of money to be able to start investing in the stock market, and you’ve shown here why that’s just wrong. I read a report once on how to become a millionaire by investing just one dollar a day. Of course, it takes many years, but it goes to show that even if you have a small income, if you start investing early you can retire a millionaire.
I am an avid investor, but I never considered DRIP investing. I am going to look into it. Thank you for the info!
If you have a brokerage account, such as TDAmeritrade, Etrade or whatever, as long as the stock or fund allows it, you can set up all your dividends to reinvest. This is no secret and it is normally a simple point and click process. You do not have to look for ‘special companies that allow DRIPs.’
Furthermore, if you have funds within an IRA you should be able to do the same… All teh retirement programs I have belonged to in the past have allowed this.
Thx jegan 😉
@ John:
All programs are not the same. I got rid of TD Ameritrade because they did not have an automated system for this (I don’t know if that has changed). I had to call them to find out which companies they supported which really annoyed me, I have to admit. However, with E*Trade, it is like you stated, just select which stock you want registered for the DRIP, and you’re done.
Great post! Here’s my positive story about DRIPs. I had a friend/co-worker who was an investor of sorts. Right after we had our son, he told me about a DRIP he participated in. It was one with the local power company, which is also one of the largest utilities in the nation. You could start out with a minimum of $25/mo. So we started one for ourselves and our son at that amount. At the time, we started (20 years ago) it was by checks with “coupons.” Later it was by automatic deduction. Each year we increased it slightly. I believe the most we ever did per month was $100 for each account during the last few years of using the DRIP (prior to that we did $40, $50, and $75 … very manageable amounts). By the time our son was 12, his account had well over $20,000 in it. We took $14K of the money and did a lump sump purchase of a tuition reimbursement plan for him. This was such a relief to have that money ready to go and not to have worry about loans, paying huge monthly fees, etc. Shortly thereafter the cost of these plans went way up so the timing was also beneficial. He’s finished two years of college and the actual funds we contributed are almost gone (they show you that in case the student withdraws from college and you want to cash in on the value of your account). We stopped contributing to the DRIPs about the time we purchased the tuition reimbursement plan and started investing more heavily in our 401Ks. However, since then we have continued to use the account to fund scholarly travel for our son (e.g., global young leaders conference). There is still a small amount of money in his account. Likewise, we have used our own account to fund different projects throughout the years. It was such an incredibly effortless way to invest and more importantly to us, like Sara stated, it was simple. We didn’t feel like we needed a financial or investment background to use this method and all it required was a reasonable payment/investment monthly. Granted it is important to pick a company that has a proven track record. And, also I agree with the person who said it is a pain to figure our the cost basis for tax purposes. However, that minor annoyance at tax time is worth it. I highly recommend this method if you do your research, which in our case included the recommendation of this friend who had no vested interest in us using the DRIP.
Company Sponsored DRIPs are a useful way to invest in individual companies for those with smaller amounts. I have invested through them for years and have had mixed results.
I would probably recommend folks focus on opening a low cost brokerage account so they can have access to any stock vs trying to open up several accounts to invest in a couple companies. However, if your interest is to invest in a particular company with small amount of money – these can be the lowest cost way to do it – a great tool for kids.
I thought I read somewhere that DRIPs could really result in a tax headache due to the large number of transactions, rather than large sums of money going in at regular intervals. Anyone know if this is true or debunkable?
Coming at this from the perspective of a young investor starting out, I’m on track to start a dividend-growth portfolio with a long-term goal, but I’m using a discount broker, not DRIPs. It should simplify the tax accounting, and crucially I can afford to invest enough to make the commissions worth it. The prospect of eventually managing more than a dozen DRIPs, each with its own fees & policies, possibly dealing with checks in the mail & address changes… no thanks.
I’m not averse to securities research, and sticking to dividend-growth companies narrows the field quite a lot. That said, the Mergent handbook for 2007 contains many banks… I wouldn’t sink my retirement money in this. An attractive alternative is Vanguard’s STAR fund, which only requires an initial $1000 investment and $100 for additional contributions for individual non-retirement accounts.
Hi Sara and J.D.
What a well written and informative post. Having never heard of DRIPs before, this gives me a great place to start learning about it.
Thanks for the information, Sara and J.D. I’ve never been introduced to this kind of investing before and I appreciate your bringing attention to it. I’ll be checking it out.
As a tax preparer I agree with what everyone said before, they are an absolute pain to track the basis of when you sell the company. Unless you do so perfectly you’ll probably ending up overpaying your taxes on these. Mutual funds are similar where people will know how much they spent initally but not how much has been purchased with their dividends, thereby not having a high enough cost basis when they sell and overpaying on taxes.
I think DRIPS were a good idea initially when they first came out, but now discount brokers and technology have replaced their former great benefits by making them obsolete and a bigger hassle then they’re worth. Who really wants to safeguard the actual stock certificates of a company they buy? Much less finding someone to buy your physical stock certificates.
Personally, I like to let my dividends just go into my basic brokerage account, then when I do my monthly investing I’ll use the dividend money to buy whatever investment I need to keep my portfolio diversified, instead of accumulating more of the same asset.
I can attest that drips work to add to your bottom line I am just an ordinary guy who reads everything i can on stock investent.I invested $1175 in my electric utility (a monopoly in my island), then followed up that with $125 per month .That time was may 1990. Today i have a small but important $87,565. This has led me to other drips such as Proctor and Gamble, Mcdonalds, GE, Exxon, Texaco, Coca Cola ,Altria Group and Pepsi.
If I set up a drip, could I just transfer the shares to a Sharebuilder IRA and then they re-invest the dividends for free?
Excluding the $cost avging paperwork…
I totlally disagree with those saying no to drips.
Those who state go sharebuilder miss the concept.
I have been doing drips for 15 years and simultaniously doing the same investings in a brokerage account.
And only 8 stocks (started with 3)..
Btw, my non-brokerage drips have nearly $50k more in them combined than I do with the brokerage.
And the brokerage was cheap to do to drip similar with them… Nearly as cheap as sharebuilder.
Fact is, drips are a paperwork nightmare but only if you dont document it when u get it… its easy with sw to do that.
Also, for some the hard part is selling it.
For others its easy.
I have in fact sold one the drips per a serious heart related deal.
Ie; once you need the $$ the drip is no longer. Though Im young enoguh still to consider restarting that one.
First off, when you do real drips, you own the stock directly.
When you buy it via any broker, you dont truely own it, but do via the brokerage.
Difference, with real drip you can go anywhere to cash the drip based stocks and in soem cases even sell it at market back to the company itself.
Though taking a ‘real’ drip and thenmoving it to IRA or brokerage,can be a costly deal.
Since it is easy to sell and or go ‘drip IRA’ its better to do it that way.
DRIP IRA’s are a bit hard to manage though I dont do them.
Also, like any other investement there are drips to stay away from.
I for one, will never as a rule go for a drip that has any fees of any kind.
There are a huge amt of ones with no costs.
The only costs I ever have is the initial setup cost ($25) and the initial share requirements), once thats done…Only the peridioic buy each month or quarter is it.
There are some really good drips that have various fees (I have only 1) that can be worth it. In those cases the cost was worth it till this year (per crash).
Wow, interesting to see so much interest in DRIPs here. I’ve written quite a bit about it, I’ve been a DRIP investor for about 10 years now, but I think I avoid many of the pitfalls mentioned above, or they’re not that relevant. Online accounts with registrars take care of all your tax forms and paperwork. So that’s no big deal. And as for risk in a single company? Not so much if you do your homework. Just because a company has a DRIP doesn’t mean it’s a great investment. I know most people don’t have the time or energy to do as much research as might be required, so for them perhaps an ETF is better (assuming they can avoid the commissions by investing huge amounts at once, of course).
DRIPs are not all of my portfolio, but they definitely got me off to a great start.
hey Sara,
I’ve been doing DRIPs for years. Simple is good, and simple and automatic is even better. Of course, DRIPs should not be the only investment strategy a person uses, but they can be part of it. I also think there are solid reliable companies out there that one can trust for a part of their portfolio. Go DRIP! ~ Justin Show
I’m trying to get my daughter to begin investing and she doesn’t have the money to pay a brokerage fee every time she wants to invest $10 – $50. In this case, a DRIP could be better than nothing, presuming she will eventually work for a company with a 401K and diversify her portfolio. As for investing heavily in one company, millions of people do just that when they put a large chunk of their money into the company they work for via their 401K rather than mutual funds. It really depends on the company, my coworkers at Chevron have done fabulous over the years, but Enron employees not so much. I think the main thing to keep in mind is that this is for those that can’t afford $7 – $10 fee every time they want to invest a small amount and maybe don’t have the discipline to invest unless it’s automatic.