How Dividend Reinvestment Plans Work
Direct Purchase Plans
My Favorite Technology DRIPs
Mutual funds have been around for a number of years, but it’s been just the last 25 or so that their popularity has skyrocketed, due in large part, to the growing participation in 401(k) retirement plans, which made mutual funds household names.
About a decade ago, exchange-traded funds (ETFs) gained traction with individual investors and began to give mutual funds some heavy competition. Unlike mutual funds that trade once a day (after the market closes), ETFs are traded like stocks—all day long. Consequently, they tend to offer more liquidity. And in the past few years, they have also emerged as good vehicles in which to park retirement money.
For individual investors, those funds have provided investors an easy way to invest small sums of money—as part of a larger pool of investors—to purchase an interest in thousands of stocks worldwide.
But what many investors don’t realize is that there is another vehicle (besides mutual funds) that offers you a means to pool your money with others to buy shares, at nominal costs. I’m talking about dividend reinvestment plans (DRIPs), which allow you to buy as little as one share of stock, at vastly reduced commissions—a very inexpensive way to start a portfolio.
Today, DRIPs are offered by about 1,000 companies and closed-end funds.
The Nuts and Bolts of DRIPs
Here’s how a DRIP works: For most DRIPs, you must buy your first share in their company stock through your broker (unless the company also has a direct stock purchase plan (DSP)), which I’ll talk about in a moment. But let’s assume you go through your broker for the first share. Then you open a DRIP (through the company or its administrator) by investing the minimum amount required by the company. For example, the Coca-Cola Company (KO) requires a minimum $500 share purchase to enroll in its plan and a minimum $50 thereafter, to make additional purchases.
Since Coca-Cola is currently trading around 39 a share, your $500 will buy you about 12 or so shares (not counting the minimal set up, investing and processing fees). After that initial investment in Coca-Cola’s DRIP plan, you can send in a minimum of $50 at a time for future purchases. Of course, if the company’s stock goes up past 50 a share (and we hope it does!), the DRIP will then pool your money with other investors to buy whole shares of stock, splitting them into fractional shares for each investor, based on the amount of money they have sent in. Then, when the company pays its dividends, those monies are applied to purchase additional fractional shares of the company’s stock.
You’d be amazed at how fast your money accumulates when you reinvest your dividends—especially when dividends—and share prices—continue to increase over time. I purchased shares in a McDonalds (MCD) DRIP when my nieces and nephews were born. When they were ready for college, they had nice, tidy sums to help them pay for all those extra expenses that popped up when they left home for the first time.
DRIPs are relatively simple, but there are a few more important points that I want you to know about them.
Selling is More of a Challenge
DRIPs are not as liquid as buying and selling shares in the open market. For the most part, you will need to sell your shares the same way you buy them—through the DRIP plan. And while the methods to sell through the plans have evolved into several alternatives from the old days when you had to mail in a notification of intent to sell, the process is still a little more complex and time-consuming than selling an ordinary non-DRIP stock.
Consequently, DRIPs are tailor-made for the long-term investor, not the trader.
In our recent Dividend Digest, I included a very informative article from Charles Carlson of The DRIP Investor, citing the different methods to sell stocks from your DRIP plan. If you are considering a DRIP, or already own one or more, I think you’ll find a lot of great information in the article. Click here.
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Direct Purchase Plans
As I mentioned earlier, some companies, like IBM (IBM), Cisco Systems (CSCO), Ford (F) and about 100 or so additional companies that offer DRIPs also offer Direct Stock Purchase Plans (DSPs). That means you can enroll in the plan through the company, not through a broker, purchasing your first share (and subsequent shares) directly through them. Here’s a good source for those plans.
However, even if you do purchase shares directly from the company, you will pay a fee to buy them. It is generally a very small one to set up the account and buy your first share. But you do want to make sure if there is a fee on additional shares purchased that it is reasonable for purchasing small numbers of shares. In other words, if the fee is $5 per transaction and you are only investing $50, that would be 10% of your total investment—too high. So watch out for those.
To find out if the company in which you are interested has a DRIP or DSP, just log on to its website, go to Investor Relations, and see if the plan is listed. If you don’t see it, contact the Investor Relations department, via email or by telephone.
If the company has a DRIP but does not offer a DSP, you might consider using http://www.directinvesting.com/ to buy your shares. This site offers DRIP investing and the editor is also one of our contributors to The Dividend Digest.
More Sources for DRIP Information
Here are a couple more sites to help you get better acquainted with DRIPs:
http://www.dripcentral.com/ for general information. http://www.dripinvestor.com/index.asp for information about new DRIPs as well as recommendations of DRIP plans and stocks.
And don’t forget about taxes! Although you won’t actually be mailed a check for dividends, you will still be receiving them (in your DRIP), so you’ll be responsible for paying taxes on them.
Lastly, it goes without saying that you’ll want to make sure that any company you invest in—via a DRIP, DSP or individual stock—meets the parameters for a solid, long-term investment. That means running it through the same tests and analysis you would any company in which you wanted to invest. And as with any other investment, you’ll also want to continue monitoring your companies to make sure that they are performing as you expect.
My Favorites DRIPs
With the economy finally turning around, and corporations sitting on hoards of cash—even after a very successful period of stock repurchase plans, rising dividends and special dividends—companies are beginning to reinvest their cash in their businesses, hiring extra employees, increasing R&D and ramping up their M&A activity. And that means one of my favorite sectors—technology—is once again on the rise.
With that in mind, I decided to review technology companies to see which ones had DRIPs that may appeal to you. After running about 25 of them through my tests, I found three tech stocks that have DRIPs and whose shares I think are trading at undervalued levels. None of them is an unknown entity. They’ve all been cutting-edge, innovative tech businesses that have had their own sets of troubles over the years. However, each company has managed to survive—and thrive—through many business cycles and economic events. They’ve almost become blue chip stocks, and they each pay a dividend.
Intel (INTC), 3% dividend yield:
Microsoft (MSFT), 2.7% dividend yield:
Xerox (XRX), 2.0% dividend yield:
If you do your homework, DRIPs can be a very rewarding and easy way to invest, and they also offer a great opportunity to teach your young relatives about the power of compounding. I can’t guarantee that they’ll all become Warren Buffetts, but it’s worth a try!