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DRIP Investing – Building Your Investments One DRIP At A Time

DRIP investing, or investing through a Dividend Re-Investment Plan, is a way to invest if you want low cost or have a small amount to invest each month. It bypasses the brokerage firms.

How DRIP Investing Works

The company offers a DRIP, typically through a Transfer Agent (the folks who manage the program).

Once you are a shareholder and are registered in the company’s DRIP program you send money to the Transfer Agent on a regular (or irregular) basis and the money is used to buy stocks in the company. There can be service charges or commissions for investing, but the cost is typically lower than investing through a broker.

Notice the sentence that starts with “Once you are a shareholder…” That means you need to already hold shares in the company. If you don’t you need to buy at least one share in that company before applying for the DRIP. There are websites out there that specialize in helping you buy that first share. The share certificate must be registered in your name.

This is a low cost system run by the company so stock purchases are made at pre-determined times of the month, or maybe even only once per month. This means that the money you send the company (or Transfer Agent) sits around until the time of the month designated for stock purchases. So, your ability to choose the price entry point is limited. If you are a long-term investor who is investing via the DRIP due to the low cost this process shouldn’t matter too much.

DRIPs allow you to invest small amounts (like around $50, but sometimes as low as $10) and the company will buy fractional shares for you. For example, let’s say you send the company $60, but one share is priced at $100. The company will purchase 0.6 shares in your name.

This is an advantage over most brokerage firms because they typically require that you buy whole shares. Sometimes odd-lot shares (share purchases that are not multiples of 100) cost more in commissions than round-lot purchases (multiples of 100 shares).

Many companies offer DRIP investors the opportunity to buy shares at below market prices. Sometimes the below market prices apply to all the shares you buy. Sometimes this only applies to the reinvested dividends.

How much below market? Probably about 3% - 5% below market. The tradeoff is you probably won’t know exactly when the purchase is made. This is to avoid giving people the opportunity to game the system by buying stocks at a discount through the DRIP and simultaneously selling shares through their other stockbroker at higher market prices locking in an instantaneous profit.

These plans are not called Dividend Reinvestment Plans for nothing. True to its name dividends distributed by the company are automatically invested for you.

Selling your shares involves writing to the Transfer Agent with your request. They sell the requested number of shares and you get your money. Some companies allow you to sell shares over the phone. The process is not quick and you don’t get to choose your exact exit point. Again, not necessarily a problem if you’re a long-term investor.

This seems like a lot of work for a company when there are so many discount stockbrokers. What’s in it for the company? The company has several incentives. Among them are the goodwill and loyalty of its shareholders. Another is the ability to raise equity cheaply.

So let’s recap the advantages of DRIP investing:

Provides a low cost way to invest
Allows you to invest in small amounts
Dividends are reinvested automatically
May provide an opportunity to buy shares below market value.

What’s the Catch?

You may have already picked up on a few downsides to DRIP investing.

Timeliness is not a strong point with this program. Getting started will take several weeks because you first need to be a shareholder, which means you need to figure out a way to buy at least one share in your name, then register for the program. Once you send your money to the company it is invested at the designated time of the month. Selling shares requires a written request or telephone call and takes a few days to execute and settle.

This program is meant for long-term investors. You will not be able to sell shares quickly if the reasons for investing in the company start to fall apart. You will not be able to control the entry or exit price.

Tracking your investments is harder. A brokerage account contains all of your positions and you get a statement each month. You can even track it day-by-day. And you can do it online. With a DRIP you are tracking and managing each investment individually.

Only a few companies offer the ability to invest using DRP in an IRA account.

You can’t participate in options trading associated with stocks like covered calls, limiting your income possibilities.

I discussed how the DRIP investing strategy makes it hard to get exit your position which you may want to do if the stock market falls. You don't have to worry about that if you employ a hedge strategy.

Many small dividend investors think that hedging their portfolio is not within their capability or beyond their means. They are wrong!

I developed a simple, effective, and low cost hedging strategy that can be easily applied to DRIP investing which I describe in my eBook.

CLICK HERE to learn more about my eBook (link opens in a new window).

Bottom Line

DRIP investing is a fantastic program if you are a small investor who wants to invest a limited amount at a low cost. This is a good program to get kids started in investing. If this is for you there are several websites that specialize in getting you started. Just Google “drip investing.” Dripinvesting.org, directinvesting.com, and firstshare.com are among the websites that will help you take the first steps in getting started. Be forewarned that many of the sites require a subscription that will increase your cost.

Opening an account with a discount online broker is a better option if you have the resources because they come close to matching the advantages of DRIP investing and offer additional advantages.

Discount online brokers have lowered the cost of investing to the point that they come close to eliminating the low-cost advantage of DRIP investing. Discount brokers like eTrade, Scottrade, thinkorswim, TD Ameritrade, and TradeKing all offer low commissions.
Buying or selling shares is accomplished much more quickly and can be done online.
Many brokerages offer the opportunity to reinvest dividends. Sharebuilder.com and buyandhold.com allow fractional shares.
Brokers allow you to employ options strategies like covered calls.
Brokers offer additional services like stock screening tools and stock reports to help you find the best dividend stocks.
Brokers allow easier and more efficient investment tracking.
It’s easier to set up and participate in an IRA.
The only DRIP investing advantage not matched by a discount online broker is the opportunity to buy stock at a discount to the market. This is not a problem for you if you are using the criteria we identified for the best dividend stocks because they are already underpriced.

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SBI!