Dividend reinvestment plans

Dividend reinvestment plans (or DRIPs) are plans offered by some companies that let shareholders receive additional shares in lieu of cash dividends.

DRIPs can be a good way to slowly build wealth over a long period, for a number of reasons. First, they eliminate the nuisance of receiving small cash dividend payments. Second, some of them let you reinvest your dividends in additional shares at a 5% discount to current prices. Third, many dividend reinvestment plans also allow optional commission-free share purchases on a monthly or quarterly basis.

To participate in these plans, you have to buy one or more shares of a company’s stock, and get a certificate registered in your name. Share registration (through a traditional or discount broker) can cost $40 or more per company. Then you call or write the company to ask for the form you fill out to enroll in the plan.

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Overall, we think that dividend reinvestment plans are OK to participate in. But here are a few things to keep in mind:

• It’s a mistake to choose investments solely or mainly due to the availability of a DRIP. The plan is only a bonus. Investing solely in stocks eligible for them limits your investment choices and diversification, and is likely to reduce your returns.
• Taxes are still payable on dividends that you reinvest.
• In addition, the advent of low-cost discount brokerage and on-line investing has reduced the commission cost of investing. That means the commission-free investing that they permit is less of an advantage today than in the past.
• You’ll need to keep careful records of all purchases to compute capital gains and losses when you sell. Many investors find this particularly troublesome, especially when they inherit the task.

From time to time we collect information on dividend reinvestment plans and publish it in one of our newsletters or special reports. Most companies that offer these plans provide details on their web sites. Companies that offer them usually mention it on the inside back cover of the annual report. Finally, you can also contact the Investor Relations department of companies you wish to invest in.

If a stock with a dividend reinvestment plan is not one we recommend as a buy, or if it doesn’t fit into your portfolio, you’d be better off using your dividends to invest in stocks that do qualify on these two measures.