The 13 Steps to Investing Foolishly
Step 5: All About Drip Accounts
"Discipline, time, and compounding are the three main contributors to successful investing -- not the amount of money with which you begin." -- Investing Without a Silver Spoon
If you've read this far, you may be raring to invest in individual stocks you've picked yourself. You might be worried about one thing, though: whether you have enough money to start. This is a common concern, and sadly we suspect that it's one of the main reasons why many people never get around to investing in stocks. They figure that it's just for the rich, or at least for those with more money.
But we're here to set the record straight -- you don't need very much money on hand to get started investing. If you have even $20 or $30 per month to invest in stocks, you can do so. You don't need to first accumulate $3,000 or anything like that. $200 to start will be more than enough.
There are many ways to plunk your dollars into stocks. The most common way is to buy all the shares you want to buy at one time. If you'd like to own 100 share of Coca-Cola and it's selling for $65 per share, you cough up $6,500 and buy the shares, paying your discount broker a modest commission of $20 or less. Alternatively, you could enroll in Coke's "dividend reinvestment program" (often called a "Drip") and spend as little as $10 monthly on Coke shares, essentially buying fractions of shares at a time -- without paying any brokerage commissions. "Drip" isn't a very appealing name, but it does get the point across. You're reinvesting dividends, but you're also "dripping" additional money into your holdings -- every month, ideally. Drip... drip... drip.... That adds up over time.
Dividend Reinvestment Plans (DRPs) and Direct Stock Purchase Plans (DSPs)
These two special types of programs permit investors to bypass brokers (and broker commissions!) and buy stock directly from companies. These types of plans have been growing in popularity in recent years and more than 1,000 major corporations now offer them. (With more companies introducing them every day.)
With dividend reinvestment plans, the company usually requires that you already own at least one share of its stock before you enroll. Furthermore, the share must be in your name. This means that if you're not already a shareholder, you'll have to buy at least one share through a broker or a Drip service.
If you use a broker, you'll need to pay a commission on this initial purchase. (More about choosing a broker in Step 6.) In addition, you'll
have to specify that you want the share(s) registered in your name, not "street name." Brokerages routinely register shares in "street name," meaning that when you buy stock through them, it's registered in their name. This is normally not a problem. It means that they hold the certificates for you and that makes it easier for you to sell quickly, without having to mail in certificates.
If you have even $20 or $30 per month to invest in stocks, you can do so.
Once you own a share or more in your own name, you can open a DRP account with the company, and buy additional shares directly through the company (or its agent).
Direct stock purchase plans operate in much the same way, except they don't require you to own at least one share before enrolling. That's right -- you can even buy your very first share through the program.
These DRPs and DSP plans vary a little from one to another. Some charge you a few pennies per share when you buy, others (the ones we like best) charge nothing. Some levy a small fee when you sell, others do not. Some permit automatic regular purchases, taking money directly from your bank account if you'd like. While some of these plans represent a great bargain, others, depending on your circumstances, might not be worth it. You need to examine the particulars of the plan(s) you're interested in before deciding to enroll.
Advantages
Clearly, these programs are a godsend for those who don't have big bundles of money to invest at a time.
They're also wonderful in that they will reinvest any dividends sent your way. This can be a really big deal. Many investors don't appreciate the power of reinvested dividends. Let's look at an example.
If you'd held shares of Coca-Cola for the 18 years between 1981 through 1998, they would have appreciated a total of 4,718%. That's an annualized gain of 24% per year. (Who said enormous global companies are slow growers?) But wait, there's more! Here's the "secret formula" for investing in Coke: if you'd reinvested all the dividends paid to you back into more shares of Coke, your total gain would have been 56% higher, at 7,364%. Annualized, that's 27% per year.
A $5,000 investment in Coke in 1981 would have grown to about $240,000 without reinvested dividends. With dividends reinvested, it would have become roughly $373,000.
More than 100 companies have plans that give investors an extra benefit, allowing them to purchase stock at a discount to the current market price. These discounts can range anywhere from one to ten percent. This provides an immediate return on investment and sometimes balances out any fees associated with setting up the plan or buying the stock. Some companies, however, only discount shares bought with dividends, not shares purchased with additional cash. Regardless, any such discount is a good thing.
Another advantage to these plans is that they permit you to slowly build up positions in stocks over a long period of time. This might not seem like such a big deal, but imagine that you really want to invest in Wal-Mart, but it seems very overpriced right now. If you're a typical investor, not using DRPs or DSPs, you'll probably wait on the sidelines for the stock price to fall a bit. If it never falls, you're out of luck. But if you go with one of these programs and choose to invest small amounts of money in Wal-Mart each month, you do establish a position in the company immediately and keep adding to it. If the stock price falls, your regularly invested amount will buy you more shares. (And you might even opt to send in more money than usual, to buy more shares.) If it keeps rising, the shares you already bought keep rising in value.
Finally, while these plans are best for those with limited incomes, they're also good for anyone who wants to invest regularly -- and you can buy as much as $1,000 -- often much more -- of stock at any time through a DRP or DSP. In fact, you can treat the plans as if you're buying each stock just once from a broker. The reason you might want to do this is to take advantage of the reinvested dividends. Be aware, though, that some brokerages now offer dividend reinvestment with no commissions. So for those with greater sums to invest, DRP and DSP plans are no longer as important as they were a few years ago.
Disadvantages
Every silver lining has a cloud, though, and these plans are no exception. A major drawback to them is the paperwork involved. If you invest small sums regularly in a handful of companies, you'll be receiving statements from each plan every time you invest. You'll need to keep everything very organized and record all your transactions for tax purposes. Taxes can get a little hairy when dealing with DRPs and DSPs if you haven't kept good records. Fortunately, there is good software on the market that can ease some of the record-keeping hassles.
Another disadvantage, although it's not a major one for most Fools, relates to timing. Let's say you're convinced of the value of a stock and are eager to buy. Using a broker, you simply make a phone call or execute the trade online. But with dividend reinvestment plans,
you have to send in a form and a check. This will take some time. Also, many plans make all their purchases and sales only once a month, delaying things further. So you might not get into the stock exactly when you want and might end up paying a little more than you wanted for it. Similarly, when you want to sell a stock, it's not going to happen immediately. It might take a few weeks. For someone who's regularly sending in checks, perhaps every month, these delays don't matter. But be aware of them.
More than 100 companies have plans that give investors an extra benefit, allowing them to purchase stock at a discount...
More Information
There's plenty more to learn about dividend reinvestment plans and direct stock purchase plans. Start with our Fool's School section on Drips which explains direct investing from A to Z. Then check out the Drip Portfolio, where we explain in greater detail how the plans work through the use of our own real money. Our Drip portfolio was launched with just $500 and we add $100 per month to it. The portfolio is meant to teach how someone with a limited budget can profitably invest in stocks. Its managers report on the portfolio's progress and discuss companies in the portfolio and companies under consideration to be added to the portfolio. (The first four companies in the portfolio were Campbell Soup, Intel, Johnson & Johnson and Mellon Bank.)
Be sure to check out Investing Without a Silver Spoon where the Fool's Drip Port manager Jeff Fischer demystifies the world of direct investing by providing everything you need to know about getting started. The primer also gives details and contact information for more than 1,000 direct investment plans (over 300 pages!) and a look at the industries and companies to strongly consider for direct investing
A motherlode of information on DRPs and DSPs can be found at Netstockdirect.com. This site lists details on just about every one of the 1,600 DRP and DSP programs. At Netstock you can download plan enrollment information, and you can also begin to invest directly online in 300 companies (and growing). Now that's convenient!
The National Association of Investors Corp. (NAIC), the country's authority on investment clubs, offers a DRP enrollment service, the "The Low Cost Investment Plan." For just $7.00 plus the price of one share of stock in any of the participating companies, you'll be enrolled and can then add to your shares regularly at little or no additional charge. You do need to be an NAIC member, however, and the annual fee is $39. For more info, click on the links above.
Other Resources
The Moneypaper website lists information on more than 1,100 companies that offer DRPs. The site also offers the Temper of Times DRP enrollment service, which will purchase initial shares and enroll investors in DRP plans for a nominal fee. Details are available at the website.
Direct Stock Purchase Plan Clearinghouse, at 800-774-4117, is free service that allows investors to order up to five prospectuses from companies that offer DSPs. (This is for direct stock purchase companies only, not DRP only companies.)
Now, onto our next stop on this Foolish journey...
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