Dividend Reinvestment Plans (DRIPs)
By: Adam Ledbetter, CFP®
The Henssler Financial Group Position Paper
Many new investors look for a way to invest a small amount of cash into the stock market without paying huge commissions. To meet this increasing demand, more companies are offering dividend reinvestment plans, also known as DRIPs. DRIPs are offered by a corporation and allow investors to reinvest their cash dividends by purchasing additional shares or fractional shares of some of the most well known publicly-traded companies for as little as $10 at a time. As a result, DRIPs have become heavily promoted as viable solutions to new investors entering the stock market.
Most DRIPs allow an investor to buy shares commission free. DRIPs also provide a means to invest with smaller dollar amounts in order to build meaningful stock positions for the long-term. In a DRIP, the shares are purchased for the investor at a fixed date and time each month, at the prevailing market price, regardless of market conditions. This methodology, known as dollar cost averaging, is a proven, effective method of wealth accumulation, and ideal for new investors.
Companies offer DRIPs for several reasons. This base of individual stockholders can help stabilize a company's share price. DRIPs also keep capital inside the company by not outright paying cash dividends but having those dividends reinvested in additional share purchases. Many companies have even made dividend reinvestment plans more convenient over the past few years with services such as online account access, direct deposit from checking and cash payout of dividends. While some DRIPs assess a nominal fee either at inception or throughout the plan, most plans can be started and maintained at no cost. But, buyer beware, a few companies have raised fees within their DRIPs to discourage small investments, so be certain to compare costs if you are choosing among several potential stocks. It is always important to obtain and review all financial material carefully before investing.
Investors should note, however, that a dividend reinvestment plan may not be appropriate for everyone. It is most appropriate for new investors just beginning a savings plan. Because shares are purchased at a fixed date and time each month in a DRIP, more sophisticated investors may find it advantageous to buy and sell shares at their discretion on any day of the week; a benefit afforded to those with accounts at a brokerage firm and not through a DRIP. Additionally, should you need to sell shares for immediate cash needs, you may not be able to do so in a timely manner inside of a dividend reinvestment plan. Many DRIPs also have maximum investment limitations. Therefore, investors with larger portfolios will be better off executing their transactions in their investment accounts despite commission costs.
Prospective DRIP investors should also be aware that it is imperative to keep good records for income tax purposes in the event you sell all or part of your shares. DRIP plans are often regarded as bookkeeping nightmares because most investors are making numerous small transactions over the course of a long period of time. Once you have accumulated a lot of 100 shares of stock inside a dividend reinvestment plan, it may be prudent to move the shares to a discount brokerage firm.
At The Henssler Financial Group, we emphasize diversification in a portfolio. For our clients, we prefer to either use a high-quality individual stock portfolio or mutual funds. Mutual funds allow even the smallest investor to gain instant diversification in the market if chosen wisely. For a beginning investor wanting to own just a few shares of stock, DRIPs may be appropriate for them.
There are many sources available for those that seek more information on dividend reinvestment plans to determine if this investing option is for you. For more information on DRIPs and their details, visit any of the following web sites:
You may also contact The Henssler Financial Group at 770-429-9166 or comments@henssler.com.