Why Investors Should Consider Investing Through DRIPs

Dividend Reinvestment Programs, DRIPs, and Your Investment Portfolio
When you invest through a DRIP, you can have a company send you regular checks for your share of the distributed profits. You can also have them automatically reinvest your dividends, instead, to buy more shares of stock in the business. Pete Gardner / Digital Vision / Getty Images

I've been receiving a lot of questions about buying stock without a broker lately. Most of the questions center around low-cost or free programs known as dividend reinvestment plans, or dividend reinvestment programs. Sometimes, you will hear these called DRIPs.

The appeal of a DRIP account is that you open it with a stock transfer agent or other sponsoring financial institution instead of with a stock broker.

With a DRIP account, you can setup regular, reoccurring purchase instructions so that money is taken out of your checking or savings account each week, month, or quarter, and used to buy shares of stock in the business in which you've decided you want to become an owner.

Many DRIPs are also direct stock purchase plans, allowing you to buy shares of a company directly from the business. Most don't charge a commission or fee for regular investment purchases. The remainder often charge a very small fee (e.g., $2.00 per transaction), helping you keep more of your money working for you to generate dividends.

It's no secret that I am a fan of DRIPs playing a role in a portfolio. I've written about how, growing up, my family taught my youngest sibling about investing by using the Coca-Cola direct stock purchase plan. When I started my first business, we opened DRIP accounts with a handful of blue chip stocks, such as Procter & Gamble and Johnson & Johnson.

I have friends and relatives that have DRIPs for their own, favorite businesses including regional banks, pharmaceutical giants, discount retailers, and packaged food conglomerates.

With DRIPs, You Can Reinvest None, Some, or All of Your Dividends

Besides their low-cost or no-cost commission schedules, a major benefit of Dividend Reinvestment Plans is they give you three options to reinvest your dividends:

  • Fully reinvest all of your dividend income to buy more shares of stock in the company (presumably, to earn even more dividends in the future)
  • Partially reinvest your dividends and send the rest to you through a mailed check or direct deposited to your checking account or savings account. You can set the percentage yourself. For example, "I want to reinvest 70% of my dividend income and have the remaining 30% direct deposited to my bank."
  • Fully pay out all dividends you earn, either through a mailed check or through a direct deposit to your bank account.

You can switch your election fairly easily. After a lifetime of saving and investing, you could then call the transfer agent, fill out a few papers, and go from full dividend reinvestment to full dividend distribution, receiving a check for your share of the company's paid out profits. If you owned 10,000 shares of Coca-Cola that you had diligently built up by putting aside some of your paycheck throughout your career, you would expect to collect $20,400 in cash dividends each year. Since Coke pays its dividends quarterly, you would expect to go to the mailbox and get a check for $5,100 every three months, four times per year. You'd be responsible for paying the 15% dividend tax (at the time this article was published).

No stock brokers. No daily stock quotes. You receive a quarterly statement showing your total ownership of the firm, your total dividend income, any additional purchases, sales, or reinvestments you've made, and a check (if you want your earnings paid out to you).

It's brilliantly simple. That is the reason you'll hardly ever hear anyone promoting DRIPs. Banks and brokers can't make money off them. It's the equivalent of going directly to the manufacturer and by-passing the store. You get all of the savings.

Which Types of Investors Should Consider DRIPs in Their Portfolio?

For long-term investors who want to pick a handful of great businesses, own them for a very long time, reinvest their dividends, and regularly buy more ownership, a DRIP is probably the lowest cost, best way to go. There are a few drawbacks, but I consider these advantages.

For example, you can't borrow on margin against stocks held in a DRIP account and you can't sell quickly (you have to telephone or fill out paperwork to start the process, which can take up to a few days), but those act as safety restraints against short-term thinking.

Most major companies offer DRIPs. To find out if the business in which you want to buy stocks has such a plan, you can call the investor relations line or check out the investor relations section of the corporate website. You are looking for a document called the prospectus, which will explain the fees and costs.