An Introduction to Dividend Reinvestment Plans (DRIPs)

As an alternative to buying stocks using the services of a brokerage firm, many investors utilize the little-known programs that allow investors to purchase shares directly from the companies themselves. There are lots of details and variations (as I'll explain later), but these plans come under the broad umbrella known as "Dividend Reinvestment Plans," or DRIPs.

A typical DRIP is operated by a public company in order to allow shareholders to have any declared dividends automatically reinvested in the purchase of additional shares of stock. A shareholder who elects to join the DRIP does not receive checks when dividends are received; the company takes that cash and ploughs it back into the purchase of more shares in the shareholder's account. (Note: the shareholder is still responsible for any taxes due on the dividend as if her or she actually received the cash.)

The primary advantage of DRIPs for individuals is the automatic investment component. Four times a year, additional purchases of the DRIP stock are made, helping the individual to follow the principle of "reinvesting all earnings," as well as using "dollar cost averaging" to buy fewer shares when the stock's price is high and more shares when the stock's price is low. Generally (but not always), there are no or minimal fees for reinvesting dividends, which is another plus for individuals. Occasionally (but increasingly rarely), dividends are reinvested at a discount to the current price.

Why do companies offer DRIPs? There are a couple of reasons, but there are two main attractions. The first is to encourage a stable base of individual ownership in the company's stock. Since individual shareholders tend to buy and sell much less frequently than institutions, public companies like having individuals holding their stocks, and DRIPs are a way to lock in a population of committed individual shareowners.

The second reason is that it provides a source of cheap and steady capital for companies in capital-intensive industries. Utilities and REITs often offer DRIPs since the reinvested dividends get immediately converted from paid-out earnings to paid-in shareholder equity, giving the company money to fund expansion or make capital improvements.

Of course, the simple automatic reinvestment of dividends isn't enough to make a lot of investors enthusiastic about DRIPs. But here's what does. Once you're enrolled in a DRIP, you can make additional purchases of stock (known as "optional cash purchases", or OCPs), often (here's the real kicker) with little or no commissions or fees. Of course, some plans require a minimum investment (which could be $50 or less, though), and there are limits to how much you can invest at one time (usually in the thousands of dollars, though, so this won't be a concern if you're just getting started). Each plan has a different schedule as to when these OCPs will be made (daily, monthly, quarterly), and they'll require the cash to be deposited in your account a certain length of time before the OCP date. This will require some planning on your part, since you'll have to make sure the DRIP has your check in hand by the deadline for the next scheduled OCP.

Back in the good old days of DRIP investing, fees and minimums for most companies were both so low that practically anyone could afford to participate in them. Today, though, it's far more common for companies to charge DRIP participants all kinds of fees, so you'll need to investigate each plan thoroughly to make sure that it works with your budget.

Still, by investing in a company's DRIP plan, you can often invest small sums as well as keep fees and commissions to the barest minimum, letting more of your dollars work for you in the stock market.

Sound good so far? There is a catch, though. In order to participate in a company's DRIP, you have to already own the number of shares required for enrollment. Each plan is different, so you may just need to own one share, or you may need to own 100 shares, but you've got to be a shareholder.

Fortunately, there are some ways that you can acquire a share so that you can become a DRIP investor, and we'll explore those options next.

How about throwing in a list of companies that still have a no cost for additional investments, or those that waive fees for auto enroll.

Hi Jeanie, no not yet, especially when I read about the storm in the Reno area this week. Mostly rain back in central IL, so far, one snow storm to speak of. Enjoying the small town life for now. Only two stoplights, includes out by the highway

Thanks for the heads up, I'll check out the site also. Hope all is well with the Sac chapter and all!!! Don't be surprised if I show up at a Sac ed fair in august one of these years.