Investing

The Good and Bad News About DRIPs

Dividend reinvestment plans, or DRIPs, have long been a way for the small money investor to build positions in a stock without incurring the steep fees you’d pay at a full-service brokerage behemoth. You simply make an initial investment in a company that pays dividends and offers a DRIP – as some 1,200 companies do – and every time that dividend is paid, it gets automatically reinvested  (generally fee-free)  in full and partial shares of stock. That compounds on autopilot over years and while helping build wealth, also removes emotional decision-making from your investing. Since you invest incrementally, and regularly, you have less chance to try to time the market or make other rash decisions.  Yet, competition from discount brokerages and low-cost funds make DRIPs possibly less compelling nowadays. Here are three points to consider before committing your cash.

1. Fees

DRIPs are known for their low fees since you generally avoid broker commissions when the dividends get reinvested. And a few even give you a 2-3 percent bonus in stock when you deposit money or each time the dividends get reinvested. But, some DRIPs do charge a commission and even a percentage of the dividend for reinvestment so you may not save any money at all by going direct. So do your homework. Directinvesting.com maintains a list of no fee DRIPs.[http://www.directinvesting.com/search/no_fees_list.cfm]

But, as discount brokers have proliferated you can now set up “synthetic” DRIPs through many. After making an initial investment and paying the brokers fee, you can ask that dividends get reinvested. Schwab, TD Ameritrade, and Fidelity all allow this, among others, for no additional fee. You can also hold these synthetic drips in a traditional or Roth IRA. However, brokers fail in that if you want to contribute any more than just your reinvested dividends you’ll have to pay the broker fee. With DRIPs if you have an extra $25, $50 or whatever at the end of the month, and want to send it in, there generally is no additional charge. And some brokers won’t allow you to own partial shares, which means your money won’t reinvest quite so quickly.

2. Paperwork clutter

Historically this has been a major knock against DRIPs. Instead of having all your investments at the same broker and on the same statement, you may end up with multiple statements from different DRIPs, and lots of separate 1099s come tax season.  Though recordkeeping has improved substantially over the years in regards to DRIPs, and new rules that went into effect January 1, should make it even better, calculating the cost basis for the IRS has often been a headache because you need to take into account all those reinvested dividends.

Setting up a traditional DRIP can be a pain in itself. While some companies run their own programs and let you buy initial shares from it, many others require you to first buy some shares through a broker (and pay a brokers fee). You’ll then need to transfer the shares to whichever company manages the DRIP program and may need to get the actual stock certificate.

Donald F. Dempsey, a fee-only Certified Financial Planner in Williston, VT, recommends finding a company that allows you to purchase the first share(s) directly –  especially if the initial investment is going to be $250 or less, so any broker fee wouldn’t take too much of a bite. Or he says if the DRIP is being opened for a child, see if a parent or relative can gift a share so the child can start with no or low cost

3. Maintaining a balanced portfolio

DRIPs can inspire a certain level of loyalty in a stock, just be sure it’s not misplaced loyalty. You don’t want to be so (emotionally) invested in a stock that you hang onto it in vain. For instance, holding on to a DRIP in the banking sector could result in years of waiting for the dividends that were slashed during the height of the recession to turn course. DRIPs obviously don’t allow you to invest in the Googles and Apples of the world (which pay no dividends), so you may need to find the tech portion of your portfolio elsewhere. For many investing in low-cost index funds or ETFs – and having the dividends reinvest – may be the smarter choice for building a diversified portfolio. And keeping those  funds, as well as any synthetic DRIPs you might have,  housed at the same discount broker will allow for easier rebalancing.

Michael Allegro is a New York-based personal finance writer who specializes in consumer interest, investing, banking products, and travel.