Another investment strategy that, like dollar-cost averaging, pays little attention to the direction of prices uses corporate dividends to boost profits over the long term. It’s called the direct investment plan, dividend reinvestment plan, or DRIP. More than 1,300 companies offer these special programs. Instead of sending you a check for the dividends your initial shares earn, the company automatically reinvests your money in additional shares. Because most companies pay dividends quarterly, your portfolio grows every 90 days without your having to lift a finger.
In a DRIP, shares are held in a common account. You receive regular statements but no stock certificates unless you request them. Companies seldom promote their DRIPs, so unless you ask about them you may not know that they exist.
DRIPs have other advantages:
- Small dividends buy fractional shares, a help to small investors.
- Many DRIPs let you make additional investments on your own. In addition, a handful of companies allow you to buy more shares with your dividends, sometimes even offering DRIP shares at discounts of 3% to 5% from the market price.
- You reduce risk by investing via a DRIP because it’s a form of dollar-cost averaging.
- Some plans charge small fees, such as a maximum $2.50 administrative fee per transaction, or $1 to $15 if you want possession of stock certificates. Brokers who hold stocks that are in a DRIP charge little or nothing to add these shares to your account each dividend period.
HOW YOU JOIN.
Joining a DRIP is easy. Just check the company’s Web site or call its shareholder relations department for a prospectus and an application, and send back the completed form. Often, you must already own some stock before you can sign up. You’ll probably have to buy your first shares through a broker, register the stock in your own name (not in the broker’s “street” name), and then transfer it to the DRIP. A small but growing number of companies will handle an initial purchase directly.
HOW YOU GET OUT. DRIPs can pose a problem when it’s time to sell. Since most DRIP investors are long-termers, companies are not geared toward sales. It used to take weeks to get your money, but things are getting a little better. Many DRIP plans now purchase shares weekly or even daily; some even permit investors to sell their shares via the telephone. In some cases you need only write a letter stating the number of shares that you wish to sell, and the company will send you the proceeds. But other companies merely mail you a stock certificate, which you must then sell through a broker. A few firms also limit selling to specified amounts, such as 100- share lots.
If you don’t plan to hold the stock for at least five years, a DRIP may not be for you. Remembering the rules of each plan can be confusing if you belong to several, and there’s no guarantee those rules won’t change. You may be limited to buying additional shares only at monthly or quarterly intervals that coincide with dividend payment dates. Money for voluntary cash purchases is often held by the company— at no interest—until the plan’s purchase dates.
All reinvested dividends are taxable for the year they’re paid, even though you don’t see the money. And if the shares were bought at a discount from the market, the amount of the discount is included in your taxable income in the year of purchase.
HOW TO PICK A DRIP. Don’t buy a stock just because it offers a direct investment plan. Evaluate the company’s fundamentals, as described earlier, and consider the following points: Check the limits if you plan to invest additional cash through a DRIP. Some companies will let you contribute as little as $10 per month. Others have higher minimums. Nearly all have maximums, ranging from $1,000 to more than $5,000 per month. Plans with the lowest minimums will be more attractive to small investors. Ask for the company’s dividend record dates—when dividends are recorded on the books. By sending voluntary payments just before the record date you can cut down on waiting time for reinvestment. The same applies when you first sign up.
Check the prospectus. A few plans let you receive part of your dividends in cash and have part reinvested.
DIRECT-PURCHASE, OR NO-LOAD PLANS. While there are hundreds of no-fee DRIPs still available, the trend has been away from them. The plans that are displacing many DRIPs offer some of the features that have made mutual funds so popular. Most retain the dividend-reinvestment option but allow investors to avoid brokerage fees entirely by purchasing even the first share of stock directly from the company. These plans are called direct-purchase plans (DPPs), or no-load stocks. Most plans allow investors to make additional cash purchases on a weekly or monthly schedule via electronic debiting of their bank account. Some even allow you to set up an individual retirement account (IRA) or sell shares over the phone. A few offer discounts on the price of the stock and allow participants to borrow against the value of their shares, as they would with a margin account at a brokerage.