DRIPs: A Little Bit of Investing Goes a Long Way

By Nancy Zambell, BrokerAdviser.com | Jun 10, 2008 | comment

Mutual funds have been around for a number of years, but it's been in the last 20 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.

And for individual investors, those funds have provided them 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 also 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 cheap way to start a portfolio.

More than 1,500 companies -- household names such as Caterpillar, McDonalds, 3M, Duke Energy, FedEx, and PepsiCo -- now offer 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 requires a minimum $10 share purchase to enroll in their plan and a minimum $10 thereafter, to make additional purchases.

Since Coca-Cola is currently trading at a little more than $56 a share, obviously, your $10 is not going to buy an entire share of the stock. So, Coca-Cola pools 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.

And each time you send in another $10, the same thing happens.

Over time, if you sent in $10 per month to Coca-Cola's DRIP, in five years (all things being equal, including the price of the company's shares), you would have accumulated $600 ($10 times 60 months) and own 10.7 shares of Coca-Cola's stock -- if the company didn't pay dividends. But because it does (currently $1.52 per share per year), each of those shares is going to receive the quarterly dividend, which will then be used to purchase more shares, quickly building up your portfolio of Coca-Cola's stock.

That's not too bad, for a $10 per month investment. Imagine what it would amount to if you doubled or tripled that monthly allocation. Plus, that doesn't take into account the probability of the company's shares appreciating over time, as well as any dividend increases Coca-Cola decides to implement. Those two factors can greatly increase your investment (without any extra money out of your pocket!).

Sounds simple, doesn't it? It is, but there are a few important points to be aware of.

DRIPs are not as liquid as buying and selling shares in the open market. You must sell your shares the same way you buy them -- through the DRIP plan. That means you can't call your broker up and sell them the same day; it might take a few days before they are sold. Consequently, DRIPs are tailor-made for the long-term investor, not the trader.

As I mentioned earlier, some companies (such as the Home Depot) 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.

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.

Some companies even offer discounts on shares purchased through them. You will need to investigate this.

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 in which you are interested has a DRIP but does not offer a DSP, you might consider using one of these websites to help you get started:

http://www.directinvesting.com/ -- This site offers DRIP investing in more than 1,300 companies.

http://content.sharebuilder.com/MgdCon/Jump/Web/welcome/buystockslpo/
index.html -- This site allows you to invest in more than 6,000 stocks and exchange-traded funds, by pooling investors' monies together.

www.betterinvesting.org -- This is the NAIC, the National Association of Investors, the folks who pioneered investment clubs. They offer a low-cost monthly investment in dividend reinvestment plans of scores of companies.

Here are a few more sites to help you get better acquainted with DRIPs:

http://www.dripcentral.com/ -- For general information.

http://www.wall-street.com/directlist.html -- For a list of companies with DRIPs and DSPs.

http://www.dripinvestor.com/clearinghouse/index.asp -- To order prospectus and enrollment information.

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 will be responsible for paying taxes on them.

For long-term investors, DRIPS can be a great way to start small and accumulate rapidly. I opened one for each of my nieces and nephews when they were born, and today, at 13, 15 and 16, they each have a nice little nest egg ready for their college years.

Lastly, it goes without saying that you will 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 like any other investment, you will also want to continue monitoring your companies to make sure that they are performing as you expect.

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 Buffett, but it's worth a try!

This concludes this week's issue of Financially Fit.  We encourage you to visit our website to review past issues of Financially Fit:

http://www.brokeradviser.com/newsletter.cfm

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