Friday, October 3, 2008

Are Drips Worth It?

This article originally appeared on The DIV-Net September 26, 2008.

The abbreviation DRIP stands for dividend reinvestment plans. Drips are a nice low cost way to purchase dividend stocks and build a stock portfolio. These programs allow investors to purchase shares in two ways either through reinvesting dividends or with optional cash payments that can be sent to the companies you want to invest in. One benefit of drips is that they allow dividend reinvestment in partial shares. Another benefit of other drips is that some allow reinvesting your dividends by purchasing shares at a discount to the market price. Two such companies that I am aware of that do this are ACAS and NNN. Below you can also check my analysis of ACAS and NNN.

One of the issues with drips is that in order to participate in the DRIP you must already have purchased one share of the company stock. Some companies have overcome that hurdle for shareholders by letting people make a direct purchase in their stock. Stocks like GE or XOM are good examples of direct purchase plans with reinvestment plans.

Another problem with drips however is that you do not have the execution speed like you do when you purchase shares through a broker. If you want to buy or sell shares at the current market price, you can’t do it. In addition to that, despite the fact most drip plans allow charge low or no fees for purchasing additional shares or reinvesting your dividends, most drips have high initial set-up fees.

Another issue that I have with drips is availability. Not all companies offer drips, so you might have to use a stock broker after all.

From a tax perspective drip Investors must track their cost of shares to be used to calculate capital gains tax when shares are sold. In addition to that very few dividend reinvestment plans allow you to hold stocks in an IRA DRIP, which allows for a tax free compounding of your dividends. Examples of non-taxable dividend reinvestment plans include XOM, which offers both traditional and ROTH IRA dividend reinvestment plans.

From a diversification perspective a drip investor has to enroll in as many plans as the number of individual companies he or she plans to invest in. This would a be very inefficient way to keep track of your investments.

The main positive of drips is the fact that one can start with a small amount of money, typically enough to buy one share of stock. DRIPs also allow novice investors to dollar cost average small amounts of money each month without getting killed on the brokerage commissions. The automatic dividend reinvestment comes in handy as if allows you to simply set up your drip with a company and then its all automatically invested into additional shares, while you take full advantage of the power of compounding.

So what is a good alternative to dividend reinvestment plans?

Most brokers allow you to purchase stock in any company that is traded on the NYSE, NASDAQ, AMEX and the OTC markets by charging you a small commission for that. After that however most brokerages do not charge any additional fees if you decide to reinvest your dividends. Some brokers like Sharebuilder allow you to reinvest your dividend by purchasing fractional shares, which accelerates the power of compounding in your favor. In addition to that, I would prefer having my entire dividend portfolio concentrated in one or two places as opposed to having it spread out among thirty different reinvestment plans. Most brokers also keep much more detailed information of your transactions activity in one place, compared to drip plans, which definitely helps during tax time.

And last but not least it is much easier to open a retirement account at a stock broker for a small fee, without being limited to the small number of drips inside an IRA out there.

DivGuy and Get Rich Slowly have both published some insightful articles on DRIPs. Check them out.

Relevant Posts:

- Why dividends?
- Why dividends matter?
- My Dividend Growth Plan - Strategy
- When to sell your dividend stocks? Part 2

8 comments:

  1. I've also published quite a bit on DRIPs. I can see many of the points you're making. I'm no longer a novice investor, but DRIPs are still a large part of my investment portfolio. I own about 20. That's enough. In addition, I have a regular online brokerage account in which I purchase non-DRIP eligible shares.

    Since there are only two registrars for the DRIPs I own, there isn't much paperwork problems to deal with. All the information is kept in two accounts online which I can log into and see the details for each holding I have with them.

    The main advantage I see with DRIPs (speaking as a Canadian investor right now) is the savings on commissions. As I don't yet qualify to receive the cheap rates at our big bank brokerages, I like not having to pay any commissions. Also, these brokerages don't reinvest fractional amounts, so in order to take advantage of any reinvestment at all you need a pretty sizeable amount of dividends coming in in order to buy new shares. So until I can do that with all my DRIP stocks, I'm happy to remain in DRIP plans.

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  2. ME,

    You have some valid points. Thanks for commenting!

    DGI

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  3. Hi! I just wanted to add that Fidelity offers FREE DRIPs for all stocks purchased through them, including Traditional IRAs and Roth IRAs. I have a very small IRA amount and I get free re-investments via their DRIP.

    The best part is that even on companies that offer discounts for doing DRIP are honored by fidelity because I imagine fidelity goes directly through the company. Seriously, what an awesome deal. The only commission is paid on entry and exit, not on DRIP. If you use one of their 25 free ETFs and DRIP, you're getting compounding interest for free, completely!!

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  4. This post is a bit outdated, but do you have any DRIP companies that you do recommend? I would like to start one for my two step-children who are 16 and 18.

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  5. Expenses in company sponsored dividend reinvestment plans can vary widely. Each one needs to be compared to a low cost brokerage to determine if its the best place for your investment

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  6. The one thing you are missing is a reference to direct stock purchase plans that are actually completely free to invest without trading or commission costs. A couple of examples include Eaton, Capitol Bancorp, Norfolk Southern, etc. You will have to consider the cost to sell the stocks but you could put together a pretty impressive portfolio with 8-10 of these, dollar cost averaging each month or quarterly.

    I have written a pretty extensive article on how to get started with these. I hope you find it useful.

    http://youthfulinvestor.com/dsp-direct-stock-purchase-plans-drip-dividend-reinvestment/

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  7. Know one here has mention that TD AMERITRADE also does drips. And there are know fee's once you bought that first one. Just talk with and they'll take care of the rest. I never knew anything about Drip's until I was talking with an old friend about stocks and how I want to look into newer avenues for my Roth account, then he mention to about these drip's. Not knowing what they were I ask and gave me the run down on them. Today I own four stocks of dips. Today am happy to say that I've watch my investment grow from a few shares to something wonderful. I just have them reinvest my dividend's. Another topic that has not been mention are 401k's most people don't even have a clue about what they have with the company store. One last thing thank you for information like this it helps a great deal to know.

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  8. A $25 initial investment in a utility stock DRIP over 40 years has grown to over $600,000. Paid $11 for 1st share. Three stock splits later, stock closed this week at $67 per share.

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