Nobody wants to spend money to save it, but that is what happens with many types of investments that charges fees. One way to avoid these fees is through dividend reinvestment plans or DRIPs. This investing eliminates the middleman and builds good, long-term investing habits.
DRIPs are a way for investors to purchase shares with dividends directly from a company. By doing so, these investors can avoid the broker fees that, while they may not seem like a lot, can actually have a significant negative impact on returns when compounding effects are taken into account.
All the dividends are reinvested in additional shares (thus a drip effect of a constantly growing investment). It is also possible to add to the investments with cash payments. The minimum purchase can be as low as $10 with fractional shares acquired when the amount is not enough for a whole share.
Over 1000 companies, (often very well known) in the US and abroad, offer DRIP investing. Some of these companies give discounts of between 3-5% and even 10% in some cases.
Who Is DRIP investing for?
DRIP investing is best for those who are looking for long-term investments, and those seeking to invest small amounts efficiently. While it generally requires some homework to find the right ones, DRIPs allow investors to put every dollar they have to work for them.
Advantages of DRIP investing
- They have low minimums and, therefore, can be started with small initial investments.
- While some companies charge fees, the middleman broker is cut out and more of one’s investment dollar can go to work earning returns.
- The automatic reinvestment keeps the money working for the investors as well as prevents it from being spent.
- Over 100 companies offer discounts on their stocks.
Disadvantages of DRIP investing
- Since investors are only buying shares in a single or limited number of companies, DRIP investing does not offer the diversity that is recommended for most people. For greater diversity at low cost, exchange traded funds are an investment to consider.
- Due to the nature of DRIP investing, it is usually impossible to sell these shares on short notice when the market is heading south or to time purchases in periods when the stock is down and offers a good buying opportunity.
Getting started in DRIP investing
It is first necessary to find companies that offer DRIP investing. For the best returns, look for stocks with a history of dividend growth. Everyone has different investment goals and circumstances, so it is necessary for investors to do their homework when they make their picks.
After picking out promising companies with DRIP programs, contact them for applications and prospects. It is important to know all the details about their programs before deciding to include maximum/minimum investments, edibility requirements and of course fees.
With the requirement to own at least one share in the company to participate in a DRIP plan, it may be necessary to use the services of a broker for the initial investment. It is also sometimes possible to get the initial shares through no-load mutual funds. In other cases, there is the option to use a direct stock purchase plan (DSP). These plans allow investors to directly purchase a company’s stock. However, keep in mind that some companies that offer DSPs do not pay dividends and thus cannot offer DRIPs.
Pointers in DRIP investing
Keep in mind that shares will need to be purchased under the investor’s name and not the street name as brokers often do.
Be watchful of fees. While there are no broker fees, some companies charge every time an investment is made. For those making regular investments of small amounts, this can add up to a lot of the investment money being lost. Those making these types of investments should either pick a company that does not charge fees or make less frequent investments but with larger amounts.
While stock is best thought of as long-term investment for the vast majority of shareholders, this is especially true in DRIP investing. Be prepared for the long haul and avoid short-term outlooks.
Types of DRIPs
There are three major types of DRIPs distinguished by the way they are run.
- Transfer agent: Since it is inefficient for most companies to run their own programs, many companies use what are called transfer agents to manage their DRIPs for them.
- Company: Some companies take it on themselves and run their own programs.
- Brokerage: While these are not formal DRIPs, brokerages will sometimes allow dividends to be reinvested at no cost. However, they do not allow cash purchases of shares without incurring fees.