Why You Should First Invest in Dividend Reinvestment Plans (DRIPs)

Over the past couple of years, more attention has been given to a type of investment known as dividend reinvestment plans – in both the popular finance news media as well as around the blogosphere.  Yet surprisingly, a lot of people still aren’t familiar with these plans that allow you to invest in stocks with no commission fees and which include fractional returns into their reinvestments.  In this post I’d like to explain the basics of DRIPs, as they’re known, in order that you can determine whether they’re for you or not and then get started quickly and easily.  It’s my personal belief that these plans are the ultimate way to bootstrap yourself to financial abundance.  Whether we are in bull or bear markets, boomtime or recession, DRIPs play an important role that should not be neglected.

RRSPs and 401Ks Don’t Always Work

I think the first (and best) thing you should invest in is a small selection (3-5) of dividend reinvestment plans (DRIPs). But I’ll qualify that a bit: if you’re lucky enough to have an RRSP or 401K where your employer matches your contributions, then by all means, max that out first. That’s free money, as they say. You might also just have an RRSP or 401K of your own without these extra monetary gifts. And if your income is high enough to benefit from any reductions that contributions to an RRSP/401K might bring, then definitely max that out too.

I disagree that maxing out your retirement savings plan should be everyone’s first investing priority. At some income levels, you simply don’t need to, because the benefits don’t outweigh the benefits you could have from bringing in cashflow through non-registered investments. When I realized that I was socking money away into a plan that I couldn’t take advantage of for more than forty years, and that I was currently getting any tax savings or benefits from doing so, I stopped. I didn’t stop investing. I redirected the money elsewhere. If you’re a student, there are better ways to maximize your “moneyenergy” for today than by socking it away into hopes for tomorrow. This is especially true if you are going through graduate or professional schools of any sort.

Start “Dripping” Your Way to Wealth

Even if you still wanted to invest for that future utopian era of your life called retirement, there are arguably better ways to do it than paying annual registered savings plan fees, trading commissions, and mutual fund fees. [Let me qualify this: there are brokers where you can hold 401Ks with no annual fee, and there are many index funds with super low MERs that you can put in them.  If your networth is already above a certain amount (like 100,000K) you might not need to pay any commissions at some brokers at all, or a really low amount like $4.95.] Many people’s money is still stuck in mutual funds where they don’t know what they’re really invested in. DRIPs, on the other hand, will allow you to invest in stocks with as little as $25 or $50. You can do it monthly and slowly build up a dividend-paying portfolio that distributes money to you on a monthly or quarterly basis. Money that you can use NOW.

No Commissions and You Only Need $50

Because DRIPs are offered by the company itself, and are managed by entities known as Transfer Agents, they bypass the middleman, the stockbroker of yesteryear. I confess that I’m a little surprised whenever I hear anyone actually relying on the services of a stockbroker in any substantial way. This is because of my do-it-yourself investment style, but also because of the vehicles I invest in. I don’t try to time the market, I don’t do options, futures and shorts. I don’t invest on margin. All of these things will seriously complicate your life, as far as I’m concerned.

Because DRIPs bypass the middleman, they save on all those commissions. It also means that for many DRIPs (at least in the U.S.; in Canada this point is a bit different), you don’t even need to use the services of a broker at all. You can just buy your shares right from the company. Wow. You really have to think about how amazing that is. Perhaps only those who have already spent years doing the broker thing can really appreciate it.

Perfect For Young Investors Just Getting Started

On top of the fact that you can save alot of money, you have the peace of mind knowing that you’re invested in some slightly more stable, dependable companies (by definition, DRIPs require that the company pay out dividends — and while some will argue (sometimes correctly) that this does not imply that the company is in a better financial situation, historically speaking dividend-paying companies that are able to increase their dividends on a yearly basis have great fundamentals, are also good growth stocks (obviously!) and not fly-by-night fads or phonystocks like Nortel or GE, Citi and GM after the credit crisis of 2008).

But because you can invest in DRIPs with as little as $25, even $10 with some companies, DRIPs are perfect for kids, teenagers, students, the self-employed, and other low- or sporadic-income groups that might come into some “extra” cash only once in a while or on an irregular basis. But don’t think that DRIPs can’t be the backbone of the portfolios of the very wealthy or high-income earners. I know the nickname “DRIPs” sounds a bit goofy, but these are the real deal. There really isn’t any other way to grow your cash this quickly and efficiently (aside, perhaps from finding a higher-paying job, of course).

Negligible Downsides

So what’s the catch, right? There are a few small drawbacks with some DRIPs, but overall they hardly constitute disadvantages to this vehicle across the board. Here are some of them. You’ll see that some might not even be important for your own situation.

(1) You still have to pay taxes on the dividends and capital gains if you sell (but divs are taxed less than your employment income!)
(2) You can only invest on a certain schedule. Some companies will take your money on a monthly basis, others only quarterly. And they’ll do it on a certain date. This means that:
(3) You don’t have control over the price you pay. While you can decide that you’ll send in one contribution of $100, you have no control over whether the stock will be up or down on the day that the company invests for you. Usually this is only of concern to hyper-market-timers, though. You’ll have a general sense of whether the stock is on sale or not. If it’s on sale, grab it when it’s low. Send a cheque in for that month
(4) Not all companies offer DRIPs. You might still have to use a broker anyway if you really, really want to invest in that favourite company of yours – or in companies that don’t pay dividends.
(5) Some DRIPs actually charge small fees for purchases and reinvestment. This is by far the worst on this list. But my advice is simply not to invest in these companies. There are enough DRIPs out there that you can build a good portfolio without having to pay for it along the way.
(6) More recordkeeping than if you held stocks at a broker. This one bothers some people. But it’s not that bad. It just means you have to stay on top of the letters and news announcements that they send you (eg., say your company is bought out, and you need to mail your certificate back in – you don’t want to miss the deadline). Most of what they send you you can ignore (I never vote by proxy, go to shareholder meetings, or even read the annual reports most of the time – I’ll do this in the future when I have more time).

Where to Get Started

How to get started in DRIPs depends on where you’re a citizen. I don’t know as much about “Dripping” in the UK or Australia, so I would love to hear from anyone living there about that. If you’re in Canada, though, you need to do one of two things: (1) buy your first share from a stockbroker like Zecco, Scottrade, BMO Investorline or TD Waterhouse. (2) get a friend or someone else who already has shares in the company you want to transfer a share over for you (after you pay him/her for it, of course!). For Canadian DRIPs there’s also a fairly good online list of Canadian DRIPs available (but not updated as frequently as we might want) here. If you’re in the US, it’s much easier to get started, because there are hundreds of companies with DRIPs (compared to Canada’s… thirty?) and many companies will let you just purchase directly from them. Some, however, do require that you first buy a share on your own. In this case just pick your favourite (cheap!) broker and get the share.

If you’re buying the share on your own first, you’ll also need to get it “certificated“. This is an extra, one-time cost that you have to put up with. Some brokers might even charge as little as $20.00 for a certificate – that’s why I liked ENorthern in Canada (which has since, unfortunately, closed shop).  Big banks in Canada will charge as much as $52.00 for the same certificate.  US banks will have fees in a similar range, I’m sure. So when you’re checking out brokers, be sure to also check their certificate fee – not just their regular trading fee.

Either route, you first need to go to the company’s webpage and find out if they offer a DRIP, and if so, how to enrol in it. They’ll tell you who their Transfer Agent is (in Canada, these are CIBC Mellon and Computershare; in the US, these are Computershare, BNY Mellon, JP Morgan, Wells Fargo, and others) and where to mail your cheque. But that’s about it! It’s straightforward from there. The Transfer Agents can be thought of as “administrative assistants” or “secretaries” that do all the bookkeeping and customer service related to these DRIP plans on behalf of the companies. If you drip Pepsi-Cola (PEP), for example, you won’t ever be dealing with anyone at Pepsi itself. You’ll be dealing with their Transfer Agent, BNY Mellon, from where you can buy Pepsi direct.

Going With MoneyPaper

In addition to the above ways of enrolling in DRIPs, you can go with MoneyPaper. They’re an independent service that helps people enrol and get their first share, and I hear they’re very easy to deal with and they do really simplify the process because they do the paperwork for you. On the other hand, they’re not a big company and so you can’t expect to hear back from them on email very quickly. They publish an annual guide to buying stocks direct. One great book explaining everything you need to know about DRIPs is that by George Fisher, All About DRIPs and DSPs. (DSPs refer to Direct Stock Purchase plans, which is what you’re doing when you buy directly from the company without needing that first share).

There’s alot more to DRIPs than what I’ve covered here so far, but this is enough to get you going. If you’ve just been given $5,000 or you’ve got an extra $100 lying around and you’ve decided it’s time to start investing, I thoroughly recommend you become acquainted with DRIPs and get into a basic one offered by a company you’re familiar with right away. As you invest, you can learn more about the DRIP universe along the way. But nothing beats these gems of the investment world. They’re no longer the “best-kept secret,” but it’s still surprising we don’t hear more about them than we do. Of course, then the brokers wouldn’t get their commissions anymore.

Let’s Talk DRIPs!

If you want to know more, or you have questions, leave a comment or email me.  What I’ve written here so far is just the surface of a world unto itself in many ways. I’ve been investing in DRIPs for almost a decade now.  While I’m not a millionaire yet, that’s because I’ve also been a student for all of that time, too.  So send me your thoughts and let me know if I can help you out.

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Tagged as: beginner investors, commissions, dividends, DRIPs, eNorthern, first investment