This is a guest post written by Retire Before Dad. He writes about dividend investing, personal finance and travel at the Retire Before Dad blog.
I’ve been an active DRIP (dividend reinvestment plan) investor since receiving my first share of Chevron (CVX) as a gift while still in college in the 90’s. DRIP investing is an easy way for individuals to get started buying stock in one company at a time. DRIPs allow investors to invest directly in a company instead of through a traditional or online broker.
Investors who want to dollar cost average into a stock and reinvest the dividends, like DRIPs for their simplicity. Companies sometimes offer discounted prices to employees through DRIPs to help build loyalty.
DRIPs are administered through Transfer Agents. These are companies such as Computershare and Wells Fargo Shareowner Services. They execute batch trades to buy and sell stock for investors, then maintain the investor’s holdings, cost basis, and dividend tax documents. Most DRIPs can be found by looking at a company’s Investor Relations page.
As a long time DRIP investor, I’ve started to move away from DRIPs because they are no longer the best way for me to accomplish my goals. For all their advantages, DRIPs have some inherent downsides.
Some newer brokerages now act almost like DRIPs by allowing small purchase amounts and dividend reinvestment for low or no fees. A brokerage account holds stocks in street name, keeping multiple stocks in one account. That makes tax time, fund transfers, and pooling dividends for reinvestment much easier.
Though I’m no longer enthusiastic about DRIPs, I still hold on to a few stocks through them. But after 20 years of investing this way, I’ve learned a few things that I’ll share with you today. These aren’t meant to imply DRIP investing is entirely bad, they’re simply things you may want to know before building out your holdings solely through direct investing.
#1 DRIPs are a Good Starting Point, But Not So Great for Diversification
DRIP investing is easy to start. Many companies allow you to start investing directly through the transfer agent. Some companies require you to own at least one share before starting the DRIP, adding an extra step.
For first time investors, DRIP investing is a simple and valuable resource for learning about stocks.
Most S&P 500 companies that pay a dividend provide some kind of DRIP. Always pay attention to the fees so you know where all of your money goes.
When getting started, young investors may invest in a company where a family member works. Acquiring the first share through a family member is easy through a gift. That’s how I got my first share. Another way is to select your first stock by choosing a company that makes products you like, and then buy it directly through the DRIP (aka DSPP).
Parents and Grandparents like to enroll their kids in the Disney (DIS) stock DRIP to teach investing. Other popular DRIPs are Coca-Cola (KO), Walmart (WMT), McDonalds (MCD), Procter & Gamble (PG) and 3M (MMM).
The best DRIP programs are often the companies with strong dividend payment histories. These companies prioritize the dividend payment and value long-term investors who stick with the company through thick and thin. Low or no fees is another sign of a strong plan.
Though buying through the DRIP is a simple way to start, you can only invest in one stock at a time. Diversification must come through investing in multiple DRIPs, or buying more stocks, funds or ETFs in another brokerage account. DRIP investing can be one component of an investment plan. But stock investors should not rely solely on DRIPs to create a diversified portfolio.
#2 Programs, Terms and Fees Can Change Without Notice
In October of 2013, I started a brand new DRIP for CSX, the railroad company, via Computershare. A month later my shares disappeared for a few days. It turns out, CSX dumped Computershare for another transfer agent company called Broadridge.
Part of my decision to invest in the CSX DRIP was that I already had a Computershare account with multiple DRIPs. All of my DRIP program shares could be accessed with one login.
With the transfer to Broadridge, I suddenly had a new account and another online login. This went against my goal of trying to simplify the number of account and logins I had. I ended up quitting the CSX DRIP and transferring the shares into my regular online broker.
Another time, I was unhappy about the Verizon (VZ) dividend reinvestment fees. So I wrote the Investor Relations people and asked if they would consider a lower flat fee, more in line with programs like Coca-Cola.
To my delight, Verizon responded that they were already considering lowering their fees. A few months later, the better fees went into effect.
But sometime after that, Coca-Cola raised their fees!
The bottom line is that DRIPs and their fees have a lot of moving parts. The transfer agents have different fee structures and deals with each company, all subject to change. So if you invest because of favorable fees and you already have a login with the transfer agent, beware that the situation can change quickly with no warning.
#3 DRIP Investing Can Negatively Influence Investment Decisions
If you only own three stocks, and those three stocks are owned through the DRIPs, you’ll likely invest more of your money in those DRIPs when you have spare cash to invest. If you invest with a regular online brokerage account, you have many more options.
For years, I invested solely through DRIPs. Part of this was due to the times. In the mid-1990’s, online brokerages were just starting to take off. Having only small dollar amounts to invest, I’d send $50 to my Chevron account because $50 was all I had and there were few other options to invest in stocks.
In other words, I invested in Chevron because it was the easiest to invest in, not because it was the best place to put my money.
Today investors have many options for low cost investing. Loyal3 and Robin Hood don’t change fees to buy or sell stocks. Other brokerages offer free dividend reinvestment and low fees.
Another way DRIPs can influence investment decisions is by fees. For example, the Exxon Mobil (XOM) DRIP at Computershare charges no fees to buy shares or reinvest dividends. Chevron, on the other hand, charges $2-$4 dollars for purchases and a $3 reinvestment fee if you own more than 200 shares.
Considering the fees, an avid DRIP investor would likely choose the Exxon regardless of which is the better value at the time or over the long term. Even though Chevron might be the better long-term holding.
Investing through a regular broker eliminates that kind of bias.
#4 DRIPs Limit Options as Your Investing Style Matures
As your investment goals, knowledge, and sophistication evolve, DRIPs stay the same.
You can’t sell a covered call from a DRIP account. Margin isn’t a part of DRIP investing. If you are not reinvesting dividends, pooling funds takes an additional bank transfer before dollars can be reinvested.
DRIPs are good for accumulating shares of one stock through dollar cost averaging over time. They’re a set and forget kind of investment.
But as your investing sophistication changes, DRIPs can seem like relics from the past. In fact, if you’re familiar with the user interface at Computershare (the biggest transfer agent in the DRIP world), it feels very slow and outdated.
Modern brokerage accounts utilize better web and mobile interfaces and offer more research tools. For the most part, DRIP transfer agents don’t offer any research tools at all.
If you’re already a DRIP investor, the first step toward moving away from DRIPs is to stop starting new ones. Then if you want to pool your dividends, it makes sense to transfer shares into a full-service online brokerage.
Transfers can be done with no fees involved. Accepting brokerages are often willing to pay the bill if a transfer agent does charge a fee. Only whole shares will transfer, any fraction of shares will need to be sold. Cost basis reporting is also transferred for transactions that occurred after January 2011. The only real downside to transferring shares out of a DRIP is the hassle of filling out the paperwork, then selling the fractional shares.
Beginner investors can consider DRIP stocks to get started saving and to help learn about investing. It’s one method for building the foundation of a stock portfolio. However, as the knowledge and sophistication level of an investor evolves, the lack of flexibility of DRIPs can be a limiting factor.
With the onset of many online brokerage account options in the past decade, beginner investors should consider other low-cost stock investing options when getting started. Doing so will make the transition from single stock investing to creating a diversified portfolio smoother.
But don’t count out DRIPs entirely. A carefully selected DRIP stock in a low-fee program is a solid way to build wealth. Getting started investing early is a top priority. DRIPs are one tried and true place to start.
Disclosure: The author is long CSX, CVX, DIS, KO, MMM, PG
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