Subject: Trading - Direct Investing and DRIPs

Last-Revised: 22 Sep 2008
Contributed-By: John Levine (johnl at iecc.com), Paul Randolph (paulr22 at juno dot com), Bob Grumbine (rgrumbin at nyx.net), Cliff (cliff at StockPower.com), Thomas Price (tprice at engr.msstate.edu), David Sanderson (dws at ora.com), John Belt, Brett Kottmann (bkottmann at webteamone.com)

DRIP stands for Dividend (sometimes Direct) Re-Investment Plan. The basic idea is that an investor can purchase shares of a company directly from that company without paying any commission. This is most commonly done in a traditional DRIP by having all dividends paid on shares immediately used to purchase more of the same shares (i.e., the dividends are reinvested). Most plans also allow the investor to purchase additional shares directly from the company every quarter. Thus the two names for DRIP: Dividend/Direct Re-Investment Plan. But note the "re" in re-investment: most DRIPs do not provide a way for an investor to buy the first share.

DRIPs offer an easy, low-cost way for buying common stocks and closed-end mutual funds. DRIPs are also a great way to invest a small amount each month (dollar-cost averaging). Since most of us try to set aside a little each month, this can work extraordinarily well. Yet another good use of a DRIP is to give a small amount of stock as a gift. You may not want to set up a brokerage account for your niece,

but you may want to give her 10 shares of Mattel. A DRIP account (structured as a UTMA, see the article elsewhere in the FAQ) helps a minor benefit from stock ownership and lets someone make additional purchases relatively easily.

When you sell shares that were acquired via a DRIP, your cost basis is simply the sum of the amounts you invested plus your reinvested dividends. But because you have four small purchases per year, at different prices, for as long as you own the stock, the actual calculation of your cost basis can quickly become an accounting nightmare. A program like Quicken or Microsoft Money can make this a lot easier for you. (There's no reason the broker can't do it for you since they have all the data, but no broker I know does.) Of course if the DRIP is structured as a retirement account, a sale is not a taxable event, and you don't need to calculate the cost basis. That leads nicely to the next caveat. In order to participate in a DRIP inside an IRA, the DRIP sponsor has to be willing to serve as IRA custodian. Some will, some won't. That information is available in the DRIP prospectus, from the company's IR department, or the transfer agent.

Traditional DRIPs are available as company-sponsored plans and from large brokerage houses. These two arrangements are both similar and different:

Company-sponsored DRIP
In this arrangement, once you have purchased at least one share, dividends paid on all holdings are used to buy new shares. That first share must be registered in your name, not in street name. A common feature is that you can make additional purchases each quarter at little or no additional cost (i.e., no commission or fees). When you sell the shares, the company buys the shares back. Note that a company-sponsored DRIP might be run by the company directly, or by a bank. The latter arrangement tends to lead to fees that quickly become onerous for small investors (more later). Many companies sponsor DRIPs; lists are available through NAIC and some brokerages.

Brokerage-house DRIP
In this arrangement, you pay a commission to buy the original shares in your brokerage account (even retirement accounts), and the brokerage buys new shares with the dividends paid by the stock at no additional charge. Thus, your investment accumulates a little at a time with no commission. When you sell the stock, they sell the full shares (for a commission) and give you cash in lieu for the fraction. Many brokerage houses offer this arrangement today, including (just to name a couple) Charles Schwab and Waterhouse.

Brokerage-house DRIP arrangements are pretty simple when compared to company-sponsored DRIPs. The remainder of this article focuses on company-sponsored DRIPs.

Once you've found a company with a DRIP, check out the plan terms. Usually the transfer agent or company's investor relations (IR) department will send you a copy of the plan information (the company's IR department may be more responsive). Two transfer agents, American Stock Transfer and Trust (http://www.amstock.com) and Chase Mellon (http://www.chasemellon.com) have extensive plan info available online. Although most of the information is available there, always verify any details that are important to you with the transfer agent or IR department before investing.

Here is a partial list of the things to check in the terms and conditions of a DRIP. Some DRIPs are exactly and only that, a Dividend Reinvestment Plan. If you intend to send in additional investments, make sure that the plan allows optional cash payments. Also, some DRIPs only accept contributions on a quarterly basis (when the dividend is paid) or even annually or semi-annually. Plans that allow optional investments at least monthly are much more convenient. Some DRIPs charge you up to $5 (or more) per contribution. If you are interested in one of those companies, then you may do just as well with a discount brokerage account at $8/trade. Still, if you want to give stock to a child or family member who doesn't have a brokerage account, paying $5/purchase through a DRIP may not be a bad idea. Finally, check whether the company issues new shares for your contribution or buys on the open market. Issuing new shares dilutes shareholder value and is therefore less appealing than buying on the open market.

Let's say the terms and conditions seem fair, and you want to get started. So you need that first share and it must be registered in your name. Once the shares are bought and issued to you, you then have to get enrolled on your own. To purchase the first share at modest cost, you have several options, as follows.

  • If you have a brokerage account, you can just buy a few shares and have the certificate issued (shares have to be in your name, not held in street name in a brokerage account). This may or may not be a low-cost approach. At Fidelity, a limit purchase order costs you a $30 commission, and it's $15 to have a certificate issued. If you have a Vanguard brokerage account, you can buy the stock for a $20 commission, then have them issue the certificate for free. Several brokerage houses (A G Edwards and Dean Witter, for example) offer a special commission rate for purchases of single shares.
  • Many clubs and other organizations will help you buy the first share for a very reasonable charge. Naturally they all have web sites; a partial list appears at the bottom of this article.
  • A handful of companies sell their stock directly to the public without requiring you to go through an exchange or broker even for the first share. In that case, just get a copy of the form from the IR department or transfer agent and send in a check. These companies are all exchange listed as well, and tend to be utilities.

Last but certainly not least, you may have asked yourself why all companies don't sponsor direct investment plans. The short answer is that it costs them too much. And now for the long answer..

Most companies, most of the time, aren't selling stock at all. For one thing, issuing new shares requires registration with the SEC, at least of the shelf variety, and that definitely costs money. Years ago, when postage, supplies, and all the rest weren't so costly, a lot of companies went ahead and did the necessary shelf registration for a Dividend Reinvestment and Stock Purchase Plan, for the benefit of those who already had at least a few shares registered in their own names, so that those shareholders could increase their holdings over time. A DRIP/SPP is a company-sponsored benefit for the shareholders, pure and simple.

In recent years, legal fees have skyrocketed, postage alone has gone to 33c for an envelope in which to send a statement of account which costs a bunch more to print than it used to, and the clerks and accountants needed to keep track of such a program have also gotten a lot more expensive. DRIP fees have gone up in existing DRIPs and there have been very few companies actually setting up their own new DRIPs, most with some kind of fee structure.

Many of these are designed much more for the purpose of generating fees for the several large banking institutions that run them than for the purpose of facilitating really small investors' interest in acquiring fixed dollar amounts of stock. Let's face it, when they take $15 just to open an account, insist on minimum investments in the mid-three to low-four digit range, and then demand huge percentage fees every time a dividend gets reinvested, a small investor gets a pretty bad deal. Always (always) check the plan terms to make sure that you can't do better with a DRIP arrangement at a discount brokerage house.

Here is a list of DRIP resources, including sources of information as well as companies that will help you buy shares at very low cost.

  • ShareBuilder.com lets you make automatic periodic investments in over 4,000 companies and 68 Index shares for about $7 per transaction. This is sometimes called dollar-based investing, because you set the dollar amount to be invested rather than the number of shares. Like any other DRIP, you can own partial shares. The company bundles the orders from members and makes bulk purchases once a week.
    https://www.sharebuilder.com
  • PortfolioBuilder lets you make unlimited automatic repeat purchases of over 550 stocks. Your investments are made in dollar amounts, not shares, allowing for the purchase of fractional shares. Fees are $150 annually (unlimited purchases that year), or $15 monthly (unlimited purchases that month), or just $3 for a single transaction.
    http://www.portfoliobuilder.net/
  • First Share is a buying club that helps investors obtain a single share so they can participate in DRIPS. The annual membership fee is $24. Members receive a membership handbook containing information about direct investing, transferring shares and registration of shares. For more information about First Share, call 800-683-0743, +1 719-783-2929, or visit their web site.
    http://www.firstshare.com
  • StockPower offers StockClick, a product that allows investors to enroll in a direct stock purchase plan, purchase and sell stock, and manage company stock online.
    http://www.stockpower.com/
  • The Moneypaper runs a website that covers thousands of companies with direct investment plans. You can use their site to open an account in virtually every DRIP plan available, or to read capsule reviews and performance analysis of those stocks.
    http://www.directinvesting.com/
  • The Rothery Report from Norman Rothery includes a list of companies that offer DRIPs and SPPs, compiled from a variety of publications, with special emphasis on Canadian companies.
    http://www.stingyinvestor.com/SI/DRPs.shtml
  • The DRIP Advisor provides information and advice on Dividend Reinvestment Programs.
    http://www.futuresforextrading.com/dripadvisor/
  • Buying Stocks Without a Broker by Charles B. Carlson
    This book lists 900 companies/closed end funds that offer DRIPS. Included is a profile of the company and some plan specifics. These are: if partial reinvestment of dividends are allowed, discounts on stock purchased with dividends, optional cash payment amount and frequency, fees, and approximate number of shareholders in the plan. Unfortunately it's out of print as of 2005, but used copies are available.

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