For investors seeking to accumulate shares of a particular company over the long term, a Dividend Reinvestment Plan (DRIP) is a cost-efficient way to use cash dividends to solidify your investment position. It's generally better for shareholders with larger dividends or investors who don't mind a slow accumulation process. If investors plan to purchase additional stock with optional cash payments, buying shares through an online brokerage may be more cost-effective due to the higher transaction fees DRIPS charge for the optional payments. Additionally, investors should be aware that DRIPs may charge high fees to sell shares purchased through the plan.
How Dividend Reinvestment Plans (DRIPs) Work
A Dividend Reinvestment Plan (DRIP) is an investment service offered by public corporations that allows existing shareowners to reinvest dividends into purchasing additional shares or fractional shares on the dividend payment date. Generally, corporations offer DRIPs through a transfer agent. Usually, a DRIP is offered in conjunction with a Direct Stock Purchase Plan (DSPP), but not always. Major corporations offering DRIPs include Johnson & Johnson (JNJ), Morgan Stanley (MS), and The Coca Cola Co. (KO), among many others.
The DRIP can be beneficial for investors with a large holding of a specific stock, investors holding comparatively high-yield dividend stocks, investors seeking to accumulate shares slowly, or any combination of the three. At those levels, the horizon is longer term, and the fees don't eat up the amount of dividend getting invested. For the casual or beginner investor holding a handful of shares and looking to quickly accumulate more, a DRIP may not be the best choice since dividend yields are on average 3% to 4% of the stock price (annualized).
For example, an investor holding 200 units of Citigroup Inc. (C) shares in Q1 2015 received $0.05/per share in dividends, which is $10.00. The dividend reinvestment fee is paid for by the company, at no cost to the investor enrolled in Citigroup's DRIP. With the $10.00 dividend and at Q1 2015 market price of $50, the investor owns a fractional 1/5th of an additional share with the DRIP. In this particular example, it may take the investor four of five quarters to own one whole share through the DRIP without any optional cash purchases (Citigroup's DRIP charges a $5.00 cash purchase fee, 50% of the quarterly dividend in this scenario).
Here are the five important things to keep in mind about DRIPs:
Many DRIPs allow dividends to be reinvested at no fee, which lets investors purchase more shares of the company at a lower cost. The plans reinvest all or partial dividends paid, based on the shareholder’s preference, into more stock, thus the name "Dividend Reinvestment Plan". Most DRIPs require that the investor be a current shareholder and that the shares owned are registered in the investor’s name.
In addition to no-fee dividend reinvestment, some companies also offer DRIPs that allow investors to purchase stock at a discount to the current market price. These discounts can range anywhere from 1 to 5% of the market price. However, investors should be aware that this discount may only extend to shares bought with dividends; depending on the company, fees (called "cash purchase fee" and "purchase processing fee") may be charged for purchases of stock not bought with dividends.
Investors should note that even though the dividends are reinvested and that no cash from the dividends was paid to the investor, for federal income tax purposes, the investor will be treated as having received dividend income on the dividend payment date. This will generally lead to a tax liability.The transfer agent will issue the related Form 1099.
To find out whether a company offers a DRIP, check the investor’s relations page on the company’s website. Generally, DRIPs are managed by transfer agents like ComputerShare, Wells Fargo Shareowner Online, or American Stock Transfer & Trust Company. To sign up for a specific DRIP, you will need to open an account with the transfer agent, which may then require you to verify that you are a current shareholder. If your shares of the stock are registered in a name other than your own (e.g., in the name of a brokerage), you may have to re-register the shares in in your own name to complete the enrollment. The transfer agent or the brokerage holding your shares will be able to assist you in this process.
Unlike DSPPs, most DRIPs do not have a minimum initial deposit requirements. However, these plans generally require the investor to be a current shareowner, so presumably you'll have some balance already invested in the company.
DRIP Fees: Buying Selling
The DRIP fee structure is similar to the DSPP structure. Unlike online brokerages that charge a standard fee per trade, DRIPs are different from company to company. Therefore, it is very important for investors to familiarize themselves with the plan prospectus prior to investing through a DRIP. Transfer agents also provide this information.
To enroll in a DRIP and purchase stock with dividends paid, investors are usually charged different types of fees, explained below:
- Initial Setup Fee: Generally, there are no associated set-up fees for DRIPs. Investors should avoid plans with set-up fees.
- Ongoing Automatic Investment Fee: This fee is charged every time an automatic investment is made, and is usually lower than the fee per trade at online brokerages. Many DRIPs waive this fee. For example, Nestle SA (NESN) DRIP does not charge an automatic investment fee.
- Cash Purchase Fee: A transaction fee for optional cash payments for purchase of stock, in addition to the reinvested dividends. The fee may differ for cash payments made by check and by debiting a bank account. For example, Citigroup Inc. (C) DRIP charges a $5 transaction fee for cash payments by check, and $2.50 for cash payment via a bank account.
- Purchase Processing Fee (per share): This fee is charged when an investor makes optional cash payment for purchase of shares, and is usually very small. Some DRIPs do not charge this fee. Citigroup Inc. (C) DRIP charges $0.03 per share for every purchase.
Like DSPPs, DRIPs usually charge a steep fee to sell stocks, which may wipe out cost savings and value gains an investor has accumulated when shares are liquidated. When selling stock purchased through a DRIP, investors may be faced with these different types of fees:
- Batch Sale Fee:
- Like DSPP, DRIPs execute trades in batches to lower costs. With batch sales, an investor may not be able to maximize gains from a stock since the investor cannot time the sale. This fee is charged when an investor sells stocks purchased through DRIPs.
- Market Order Sale Fee: Investors are charged this fee to sell stocks outside of the batch system. DRIPs often charge a higher fee for a market sale compared to a batch sale.
- Batch Sale Processing Fee (per share): This fee is charged every time a batch sale is made, and is usually higher than the Purchase Processing Fee. For example, The Coca Cola Co. (KO) DRIP charges $0.15 per share for every batch sale.
- Market Order Sale Processing Fee (per share): This fee is charged every time a market order sale is made, and is usually the same as the Batch Sale Processing Fee.
DRIPs vs. Online Brokerages
It’s difficult to compare a DRIP with an online brokerage since companies such different fee structures. Below we show a simplified comparison of how a DRIP plan works versus purchasing stock via an online brokerage like OptionsHouse, one of our favorite beginner brokerage firms.
|Company X DRIP||Sample Brokerage|
|Number of shares owned at T1||20||20|
Share price at T1
Q1 Dividends at $0.25 per share
Share price at T2
Fee to purchase
Number of shares purchased with reinvested dividends (incl fractional shares)
Our simplified comparison shows that by purchasing stock through an online brokerage, an investor may very well wipe out all dividends received. With a DRIP, an investor can increase the number of shares owned at zero cost. However, this conclusion does not apply to all cases, especially if the investor wants to purchase more of the company's stock with extra funds beyond what they get in dividends. Transaction fees charged by DRIPs for optional cash payments may very well be more than the fee per trade charged by online brokerages. It is important for investors to read the DRIP prospectus before making investing decisions.
Purchasing stock with dividends through a DRIP is a cost-effective option for investors seeking to solidify their investment position. However, if an investor is seeking to purchase more shares with optional cash payments on top of their dividends, a DRIP may not be the best choice.