Follow on TwitterLike on FacebookFollow on Google+Subscribe to RSS Feed

DRIPs: Maybe The Best Investment in the Post Market-Crash Environment

Source: sxc.hu Photo: ilco
Source: sxc.hu Photo: ilco

Now that the word “recovery” seems to appear more often than “recession” in the news media, many investors who have been waiting on the sidelines (and there are still quite a few of them) might be wondering what to do with their money.

  • Is it safe to leave it in the hands of a third-party broker, post-Madoff?
  • Is it safe to stash it in the money markets, post-lending crisis that “broke the buck”?
  • Is it safe to put in your home, now that real estate prices clearly no longer always rise?
  • Is it safe to leave it in savings account, now that even the FDIC is almost bankrupt?

These are some dramatic examples, and I’m not suggesting that all financial advisors or banks are untrustworthy.  But they do illustrate the breadth and scope of the risk that can extend throughout the investment world.  Even if you just held the most basic of financial instruments during the 2008-2009 credit crisis — like a mortgage, and a money market fund — you may not have been immune from the great stock market crash of this century.

So where does that leave you today?  You know you need to seek out more return than the average savings account, but you don’t want to be caught up in market timing – you just don’t have time for all of that.

Tread Carefully With ETFs

One great option lies with pure ETFs that passively track a broad-based index – you don’t need to do constant research, just put your money in and wait.  But choose carefully, because not all ETFs are pure passive index-trackers anymore.  Some include active management.  And some are far more risky than that, rebalancing daily and doubly or triply leveraged to the underlying index.  All this can wipe out your principal faster than you can think of the first three major bank failures in 2008.  Besides, you have to pay a commission fee each time you want to purchase an ETF, and on top of that they still include some management fees, even if these are much lower than your typical mutual fund.

The Perfect Investment?

What if there was a way you could invest in equities without paying any commissions or management fees, and still get the benefits of passive index investing?  This is where DRIPs come in.  Also known as DRPs (Direct Reinvestment Plans), or DSPs (direct stock purchase plans), the DRIP universe is quite large and varied.

The DRIPs I’m referring you to comprise a small galaxy within that universe.  These are the DRIPs with no fees whatsoever. You can purchase company stock and have your dividends reinvested for free.

“DRIP” is just a loose term for any one of these plans which allows you to buy stock directly through the company itself (not through a stock exchange) and in which, usually, the company has your dividends reinvested back in the same stock.  I like to think of it as a high-return savings account (with the added risk that comes with equities).

Top 5 Reasons DRIPs Are The Best Place For Your Money Now

  1. No More Fees: Cut Out the Middle Man.  As I just mentioned, there are many DRIPs with companies that charge no fees to purchase or reinvest your dividends back into the stock.  This beats even the lowest management fees on any Vanguard ETF. You’ve just lost a ton of money in the Great Recession.  Why pay more than you have to again, now?
  2. Invest In What You Understand.  Face it, do you really know how your money market fund is structured and how it produces its returns?  What could be more simple than owning shares in Coca-Cola or PepsiCo?  At least if you buy the stock, you can get some of the money back on all the Pepsi products you have consumed over the years.  DRIPs are very simple products.  The company grows, it makes money, and it gives some of its profits back to you.  You can make things even simpler by choosing a company that sells simple products, like beverages.
  3. More conducive to dollar cost averaging.  Broad consensus says that dollar cost averaging is better than trying to time the market.  You don’t have to sit around reading the news or paying attention to what the S&P is doing.  Just invest the same amount on a monthly basis.  This can really add up if you’re DCA-ing with an ETF and you’ve got a monthly commission plus that 0.5% MER.  With a fee-free DRIP, you don’t have to worry about monthly charges like this.
  4. Stronger Companies, and You Don’t Have to Stock-Pick.  Companies with DRIPs are companies with a history of paying out dividends, which means they are usually more mature companies within their sector and have a stable cashflow payout.  This already means the company is less risky to you as an investor.  If the company is in trouble, it can always reduce its dividend a bit to drum up some cash before needing to dilute its shares on the market.  Also, a public history of stable dividends is a great way to show a company’s strength.  For this reason, some companies fiercely protect their dividend stream.  Because of this, there is much, much less stock-picking and screening for you to do.  Stick with the companies that provide free DRIPs and which also increase their dividends regularly and you’ve already screened them out on two levels of risk.
  5. Get In Now While Dividend Payouts Are Still Low.  During the depths of the recession, some companies reduced their dividends in order to better buffer their cashflow positions.  In most cases, dividends have still not recovered from the crash.  This means there is still more upside.  If you invest more money in these companies now, you will benefit even more when they do start to raise dividend payouts again.  A dividend increase is a healthy sign of earnings growth, which can cause the share prices to rise.

DRIPs Aren’t Risk Free, But They Are Risk-Reduced

All this being said, just because a company has a DRIP doesn’t mean it is a great company with no risk.  Once you’ve identified a handful of excellent DRIP plans, you should still do some basic initial research and evaluation of the company to determine whether it’s a good long term investment.  The best DRIPs are those with companies that show signs of success over the long term and prospects for consistently rising dividends.  And remember:

All DRIPs are different. The ones I am recommending you consider are those that do not charge you any fees on neither optional stock purchases NOR dividend reinvestment.  Of course, it is your investment: if you decide that a company’s stock is worth the fee you might pay, that is up to you.

How To Find and Enrol in a DRIP?

How do you know if a company has a DRIP?  Go to its website, click on “Investor Relations,” (or “Investor Center”) and you will usually find an FAQ section or a “Shareholder Services” section.  Here you will see whether they have a DRIP or not.  Read the DRIP prospectus to find out whether there are fees involved with the DRIP.

Best bets for finding DRIPs are with the large, stable dividend-payers like utilities companies, consumer products, some banks, and telecommunications companies.  Home Depot has a DRIP, as does Johnson & Johnson, Walt Disney and Kraft.

To enrol in a DRIP, just follow the instructions from the company’s website.  They will be slightly different for each company.  You will end up dealing with the company’s transfer agent (which is like an administrative assistant) – Bank of New York Mellon, Wells Fargo, Computershare are the big ones.

DRIPs just might be the best solution for your money today.  They are a nice “middle road” between active and passive investing; they will give you greater return with less risk than simply owning a basket of all the good stocks with all the bad stocks, and they’re easy to understand.  Some even call them “training wheels” for learning how to invest in equities more generally.  They’re great for beginners, and many use them to give as gifts to their kids to get started in investing.

Whether you end up investing in DRIPs or not, it’s definitely worth your time to give them some good consideration.  For more information, see the quick guide I wrote on on how to get started in commission-free, fee-free investing.

Comprehensive Guide to the Best Dividend Stocks for 2011 is coming soon.

Sign up to be notified when the guide is released.

Absolutely No Spam. We will not rent or sell your email address

4 Responses to DRIPs: Maybe The Best Investment in the Post Market-Crash Environment

  1. If anyone has questions about DRIPs, send me an email or find me on twitter, I’d be happy to say more. Follow that link to my site, too – lots of info there.

  2. If a company is paying dividends, it is a better investment than most. Increasing your holdings without a broker’s fee makes it even better. This sounds like a strategy worth pursuing. Thanks for the how to.

  3. Keith, there are many online stock brokers who also offer complimentary dividend reinvestment options. They may not be available for all stocks but it doesn’t hurt to find out. I know some brokers, like Fidelity, where these dividend reinvestment programs don’t charge you any commissions

Leave a reply