Dividend Reinvestment Program (DRIP)

The Dividend Reinvestment Program or Plan (DRIP) is becoming increasingly popular among individual investors. Let's take a look at what exactly a DRIP is and some of the key types of DRIPS.

We will also examine some of the advantages and drawbacks of these plans.

What exactly is a Dividend Reinvestment Program?

A DRIP is a program that lets an investor use the amount that a company pays as dividend to buy more company stock. The additional stock can be purchased for little or no commission. Also, the additional shares don't have to be whole quantities ... you can buy partial shares, too.

Even though DRIPS primarily started off as a way to re-invest dividends, you can now purchase company shares with additional capital (non-dividend capital). To do this, you usually have to enroll in a complementary program called a Share Purchase Plan.

Obtaining the Stock

So how do you go about actually buying stock through a DRIP?

Most plans require you to become a registered shareholder of the company. A registered shareholder is a direct owner of company stock and is listed either with the company or its transfer agent .... a bank or a trust the company pays to manage its shareholder information.

As you can see, this is a different form of stock ownership compared to when you buy a company's stock using a broker. When you buy stock using a broker, the broker acts as your proxy and you become what's called a beneficial shareholder.

Types of DRIPS

Dividend Reinvestment Programs can be grouped into three types based on who runs the program:

1. Company-run: Here the company runs the program directly and lets you buy stock from them ... sometimes even if you don't own any of the company stock prior to your DRIP purchase.

2. Transfer Agent-run: Managing a DRIP requires a lot of administrative effort. Some companies sub-contract this out to a bank or a financial institution called a transfer agent. Since a transfer agent uses the same resources to manage DRIPs for multiple companies, it can keep its management cost lower.

3. Brokerage-run: Several brokerages offer DRIPs even though the company behind the stock doesn't. However, these programs allow you to only reinvest dividends and not additional capital.

Advantages

• Easy to enroll — forms take very little time to fill out.

• Automation — once enrolled, each time a company pays out dividends, they are automatically invested.

• DRIPS allow you to invest even small amounts at very low costs.

• Flexibility — not all the dividend needs to be re-invested. You can specify how much of it you want to keep as cash and how much you want to buy stock with.

• Some companies even allow you to purchase their stock below market value.

• DRIPs make the investor purchase stock at regular intervals building in dollar cost averaging into the program.

Drawbacks

• Record keeping — to figure out your capital gains during tax time, you need to have kept good records of all your cash investments and dividend reinvestment in the DRIP. This can be time consuming and demands a systematic approach.

• Limited access — not all companies offer DRIPs.

• While dollar cost averaging helps most investors, those investors who know how to value stocks are at a disadvantage because they can't pick the reinvestment price for dividends.

Additional Resources

Here is a good website that we like. Take your time to read and understand the offerings before signing up.

Moneypaper's directinvesting.com

In summary, we discussed what a Dividend Reinvestment Program is, the different types of DRIPS, and the main advantages and drawbacks of DRIPS.

DRIPs are a great way for a beginning investor to get started with stock investing with limited resources. As always, read and understand the program before committing resources.

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