Dividend Reinvestment Plans

by Salary.com Staff - Original publish date: January 18, 2012

If you're short on cash but keen to build an investment portfolio, you may want to consider a DRIP. Shorthand for Dividend Reinvestment Plans, DRIPs allow individual shareholders to bypass brokers and make stock transactions directly with certain publicly traded corporations. The beauty of DRIPs is that they offer us all a way to get into the market - even on $50 a month.

More than 1,000 corporations offer Dividend Reinvestment Plans, from blue-chip companies like IBM, Chevron, and McDonald's, to overseas firms such as British Telecom, Elf Aquitaine, and Sony. To get yourself started on one, choose from an extensive list and begin by purchasing your first shares (bear in mind, though, that some companies like Hewlett-Packard require a minimum of 10 shares).

That first share can be acquired through a broker, but it must be registered in your name, even though most brokerage houses tend to favor holding it for you under its street name. Or you may want to acquire that first share through one of the many Direct Stock Purchase Plans that an increasing number of corporations have been offering, including Procter & Gamble and Exxon. Once you hold a share in your name, request from the company a DRIP prospectus that will cover all the information you'll need to participate.

Reinvesting earns you more money
DRIPs are useful for many reasons. Because they allow you to commit small sums of money over time, they build your ownership of shares slowly and at varied prices. As dividends drip in, the company applies the earnings toward the purchase of more shares. You might be surprised at the difference this reinvesting can make - a straight $5,000 investment in Coca-Cola at 1981 prices, for example, would be worth $240,000 today. If dividend reinvestment were factored into the equation, that sum would be more like $373,000.

DRIPs incur few or no fees, even when you frequently contribute to them. Once you've signed on, you can forward additional money on a regular basis to buy more shares. According to Charles Carlson, CFA, author of "Buying Stocks Without a Broker" (McGraw-Hill Professional Publishing 1996) and editor of the DRIP Investor Newsletter, "this is where the real oomph comes in. Some companies even give you opportunities to buy their stock at less-than-market prices, usually at a discount of about 2 to 5 percent." Since this usually applies to shares purchased with reinvested dividends, the amount of stocks you would be able to buy at such a discount can be somewhat limited.

Timing your DRIP can be tricky
As with everything, DRIPs have their disadvantages. Timing is one. In today's world of real-time investing, many people want to execute decisions instantaneously. DRIPs don't work that way. One must complete a requisition order and send it with a check to the relevant company. What's more, investors should be wary that some companies only allow for such transactions at a certain time each month. The same goes for selling, which can take several weeks. Offering a tip around this drawback, Carlson said, "You can write the company ahead of time and request them to send you the actual stock certificates. Once you have those in hand, you can walk into any brokerage and sell them at the exact time you want."

The tax man cometh
To be sure, DRIPs require a lot of diligence on the part of the investor. They create a load of paperwork and scrupulous record keeping because taxes can get thorny with DRIPs. If you participate in several different DRIPs, you'll receive as many different statements, which won't all be consolidated on one sheet like a usual brokerage statement. And keep in mind as tax season approaches that dividends, even if they're reinvested, are taxable and each company will send you a 1099 form for reporting.