If you'd like to crush the market, there is no better way than reinvesting your dividends.
In Jeremy Siegel's recent book, The Future for Investors, he lays out numerous examples of the profound effect of the dividend. Among the examples he uses, returns on investing from 1871 to 2003 illustrated his point best. Siegel found that 97% of the after-inflation return from stocks over the period came from reinvesting dividends. To put it another way, the after-inflation return on equities over that period is 7% with dividends reinvested and 4.5% without.
That's why reinvesting dividends works, but what about how to effectively reinvest? I'm glad you asked. The traditional way to reinvest is to set up a dividend reinvesting plan (Drip) directly with the company or its transfer agent. Earlier this week, my Foolish colleague Selena Maranjian offered up another method, which is to invest in dividend payers in your traditional brokerage account and then reinvest those dividends in the best opportunity available at the time instead of automatically rolling the dividends over into the company that's paying them.
There's a sound value argument to Selena's suggestion, but there's another reason her idea makes sense: fees. Drips have been so attractive partly because you didn't need large sums of money to get started and many of the plans were free of fees. The sad fact is that many dividend reinvestment plans today aren't as attractive as they used to be, because they charge relatively high fees.
Since we all need a few dividend payers to balance out the high growth companies in our portfolios, let's take a look at a few companies that charge too much to Drip and some that still offer investors a good bargain.
Mmmm. mmmm. bad
Unfortunately, consumer products companies and well-known Dow components charge some of the highest Drip fees. To start a dividend reinvestment plan with Campbell Soup (NYSE: CPB ) , for example, you'll pay an initial $15 fee, which isn't so bad if you fund your account with at least $750. However, for each automatic contribution to your account you'll pay a $2 fee and any optional manual contributions get hit with $5 fees. To keep fees under 2%, automatic contributions must be at least $100 and optional contributions should be a minimum of $250.
However, the plan's worst fee is the 5% charge (up to $3 maximum) on reinvested dividends -- particularly if you're reinvesting in a taxable account, which is most investors' method of choice, since the taxman will be taking his 15% as well. Campbell's isn't alone in charging fees on its Drips. IBM (NYSE: IBM ) has a similar structure, with an initial fee of $15, $1 fees for automatic contributions, $5 for optional contributions, and 2% up to a max of $3 on dividends reinvested. Wal-Mart (NYSE: WMT ) has similar fees, but it doesn't charge for reinvested dividends. And even Wrigley (NYSE: WWY ) , which has been a longtime dividend reinvesting success, will charge fees in its Drip starting on Dec. 1.
Plans that really help you grow
Luckily, there are some options left for investors who want to establish dividend reinvestment plans without having to pay fees. For example many banks, including Bank of America and BB&T, do not charge fees in their plans. Neither does recent value play Avon Products (NYSE: AVP ) , which carries an intriguing 2.7% yield.
In the high-yield industries of the stock market, many utilities have taken to charging fees, but I was able to find a number of REITs that don't. Two worth considering are Boston Properties (NYSE: BXP ) and Washington Real Estate Investment Trust. Considering the substantial yields that many REITs have offered in the past, the potential for outperformance through reinvesting is fairly substantial. However, note that your tax bill for REIT dividends will be at the same level as your income, because REITs do not pay corporate income taxes as long as they pay out 95% of net income.
Foolish final thoughts
Dividend reinvesting plans have become more expensive, but there are countless plans that give investors a great deal. Just be sure to read the plan prospectus carefully before enrolling.
If dividend reinvesting sounds like your thing and you're interested in learning about more companies that have accommodating dividend reinvestment plans, take a free trial to our Income Investor service. Each month, lead analyst Mathew Emmert recommends two dividend-paying companies, with information about each selection's dividend reinvestment plan. After a little more than two years, Mathew's recommendations are beating the market by an average of 3% and 11 of his selections have beaten the market by 15% or more.