Reader Question: What Do I Think of DRIPs?

I had a reader send me this question a couple weeks ago:

I was curious what you thought of dividend reinvestment plans. I took some tests for work, and the bonus checks will be coming soon. I have plenty of money in the emergency fund, and started a Roth IRA. I want to put this money to use, not just having it sit in a bank account. I was thinking of starting a DRIP with a company I am not already invested in through my 401k or Roth IRA.  I don't want to get overexposed to one company.

Just to catch everyone up to speed, here's an overview of what DRIPs are. The summary:

A dividend reinvestment program or dividend reinvestment plan (DRIP) is an equity investment option offered directly from the underlying company. The investor typically does not receive quarterly dividends directly as cash. Instead the investor's dividends are directly reinvested in the underlying equity. (It should be noted that the investor still must pay tax annually on his or her dividend income, whether it is received or reinvested.)

This allows the investment return from dividends to be immediately invested for the purpose of price appreciation (and compounding), without incurring brokerage fees or waiting to accumulate enough cash for a full share of stock. Some DRIPs are free of charge for participants, while others do charge fees and/or proportional commissions.

Here's how I responded:

Generally, I think they are a good deal if you're interested in one stock in particular as they decrease costs in acquiring the stock. However, you must be willing to deal with extra paperwork as each DRIP will be its own account (as far as I know) versus being able to hold many stocks in one brokerage account.

I used to invest in DRIPs quite a bit several years ago (as they were first getting established in a major way) as I was investing in individual stocks a lot and they were a way to reduce some trading costs. However, I soon became buried in paperwork while simultaneously realizing that I wasn't the next Warren Buffet when it came to stock picking. So I closed out all my DRIP accounts and plunged headlong into index fund investing, where I've been ever since.

Comments

[tinyhands]

It has been my experience that DRIPs are no more complicated to set up than a regular brokerage account. It's merely a choice to be made when establishing: cash dividends or reinvestment. I believe it's all or nothing with the account though, not a per-investment decision.

But the way I see it, DRIPs are too much trouble outside of an IRA. If the average company/fund pays a dividend quarterly, that's 4 transactions per year on which you have to keep track of the basis. If you're well-organized with other programs like Sharebuilder or dollar-cost averaging and keep good records, there's nothing wrong with it. But in a regular taxable account, you either need to report an average basis or lot identification for sales and a DRIP can make that much more complicated.

Regardless of the account type, if you're anal about asset allocation and portfolio rebalancing (and the experts say that you should NOT be) DRIPs will alter the balance of your allocations as some investments have higher dividend yields than others.

Lest you think I completely hate them, I'll say something nice: They're an EASY way to be fully-invested in a particular account, since cash will not accrue.

(Note: I have no experience with Sharebuilder, so I may be wrong in that specific case.)

[FMF]

My comments above weren't about the difficulty in setting up a DRIP account, they were about managing them. Why have separate DRIP accounts for P&G, GE, Microsoft, and a few other companies when you can own all of them in a single brokerage account?

As you can see, they get to be an administrative burden if you have many stocks you buy this way.