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Younger investors often want to invest in stocks that offer dividends, but they do not need the income from dividends the way older investors do. For these type of investors who are more interested in portfolio growth than income, dividend reinvestment plans (DRIPs) are a great option.
A DRIP is a program that allows current stockholders to purchase stock directly from the company with the dividends that the company pays. Essentially the investor is reinvesting their dividend payments directly through the company, and bypassing stock brokers and the commissions they charge.
Use the Dividend Screener to find high-quality dividend stocks. You can filter companies in a variety of ways using the screener. For example, if you want to focus on an industry that pays high dividends such as utilities, you can do that easily with the screener.
Not all companies offer DRIPs, but at least half of all dividend-paying firms do. Today, there are roughly 1,200 U.S.-listed companies that offer DRIPs to investors based on data from the Center for Research into Securities Prices (CRSP). Investing through DRIPs can make a big difference in your net worth over time. By reinvesting dividends that are paid out, you continue to build net worth and income that compounds on autopilot over years. While DRIPs help in building wealth, they also remove 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 ill-advised decisions.
Those 1,200 DRIPs out there come in two varieties – fee and no fee.
In general, DRIPs are regarded as being a low-fee investment option since you generally avoid broker commissions when the dividends get reinvested. In fact, a few DRIPs even give you a 2-3 percent bonus in stock when you deposit money, or each time the dividends get reinvested. However, just like the underlying stocks, DRIPs vary across companies; some DRIPs charge a commission and even a percentage of the dividend for reinvestment. In these cases, you may not save any money by going direct with a DRIP. So, the point is that like all investment decisions, you need to do your homework.
The other point to consider with direct DRIP investing is that it does create more paperwork. By holding stocks with both a broker and potentially many different companies directly, it is harder for the investor to balance their portfolio, assess their holdings, and generally keep an eye on investments.
How can you learn more? Check out our DRIPs 101 here.
The alternative to investing directly is to invest through a brokerage firm. As competition has heated up across the brokerage industry, many brokers now let you set up “synthetic” DRIPs. Basically, the only difference is that rather than buying shares from the company itself, you are just using the dividend payment to buy more shares on the open market through the broker.
After making an initial investment and buying a stock the first time (and paying the brokerage commission of course), you can ask that dividends from that stock get reinvested. E*TRADE, Schwab, TD Ameritrade and Fidelity all allow this, as do many others. And these days, there is generally no additional fee for the DRIPs. In fact, you can even hold these brokerage DRIPs in a traditional or Roth IRA. For younger investors looking to build wealth toward retirement over time, this is a great option.
There are downsides to using a broker for your DRIPs, though. In particular, brokers are happy to let you reinvest your dividends, but they don’t want to undermine their own core business. As a result, if you want to contribute any more than just your reinvested dividends, you’ll have to pay the broker fee. If you want to reinvest $100 that you received from a dividend, that’s no problem and there is no commission. If you want to reinvest that $100 plus another $100 you have set aside, now you face regular commissions. In an age of discount brokers, those commissions may not be a lot for any individual trade, but they do add up over time.
In addition, some brokers won’t allow you to own partial shares, so you may end up having to wait until your dividends add up to enough that you can buy whole shares. For low-priced stocks, that’s less of a problem than it is for high-priced stocks like Goldman Sachs or Apple. And being slower to reinvestment means your money won’t grow as fast.
Several companies have modified their DRIP fee schedules to attract or maintain an investor base. Nowadays, there are companies that charge no fees when an investor opens a DRIP account, buys shares or reinvests dividends; however, there is a fee when the investor sells those shares. For instance, 3M (MMM ), ExxonMobil (XOM ) and Union Pacific (UNP ) fit this profile of DRIP providers.
Want to learn more about misconceptions about DRIPs? Click here.
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To invest in a stock by reinvesting your dividends, you will take one of two different routes. If you are going to invest through your broker, contact them and ask to begin reinvesting your dividends. For a single stock, that is easy to do, but if you hold many different stocks, there will be a bit more paperwork required. Either way, you just have one party to contact.
If you want to reinvest directly with a company, you will need to check with the investor relations department for each company with which you want a DRIP. Each company works a bit differently but the process is pretty straightforward in most cases.
For example, here is what Pepsi says about investing directly with them.
PepsiCo’s Direct Stock Purchase & Dividend Reinvestment Plan, sponsored by Computershare, allows interested investors to purchase shares of PepsiCo stock. Investors can make their initial purchase of PepsiCo stock and additional cash investments through the plan. The plan also offers dividend reinvestment and sale of shares.
Want to learn more? Here is our take on everything investors need to know about DRIPs.
Assuming an investor is focusing on a no-fee DRIP, the savings are potentially significant. With four dividends each year, over a 10-year time frame, the investor would save the cost of 40 commissions or fees by using a DRIP, plus, depending on the stock, they might get 2-3% in additional stock for the same price. Assuming a $7 trading fee, that means almost $300 in commissions, plus around $30 of additional stock for every $1,000 invested assuming a discount program from the company. When it comes to building wealth, every little bit helps!
One caveat though – don’t just go for a company that has a no-fee DRIP. Research the company before investing. Happy DRIP-ing!
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