All About Drip Accounts

If you've read this far, you may be raring to invest in individual stocks you've picked yourself. However, you might be worried about one thing: whether you have enough money to start. This is a common concern, and, sadly, we suspect that it's one of the main reasons why many people never get around to investing in stocks. They figure that it's just for the rich, or at least for those with more money.

But we're here to set the record straight. You don't need very much money on hand to get started investing. If you have even $20 or $30 per month to invest in stocks, you can do so. You don't need to first accumulate $3,000 or anything like that. Starting with $200 can be more than enough.

There are many ways to plunk your dollars into stocks. The most common way is to buy all the shares of a company that you want to buy at one time. If you'd like to own 100 shares of Coca-Cola (NYSE: KO) and it's selling for $45 per share, you cough up $4,500 and buy the shares, paying your broker what should be a modest commission of roughly $20 or less.

Alternatively, you could enroll in Coke's "dividend reinvestment program" (often called a "Drip") and spend as little as $10 monthly on Coke shares, essentially buying fractions of shares at a time -- without paying any brokerage commissions.

"Drip" isn't a very appealing name, but it does get the point across. You're reinvesting the dividends you receive into additional shares or fractions of shares of stock, but you're also "dripping" additional money into your holdings -- every month, ideally. Drip... drip... drip.... That adds up over time.

Dividend reinvestment plans and direct stock purchase plans

These two special types of programs permit investors to bypass brokers (and broker commissions!) and buy stock directly from companies. The plans have been growing in popularity in recent years, with more than 1,000 major corporations now offering them.

With dividend reinvestment plans, the company usually requires that you already own at least one share of its stock before you enroll. Furthermore, the share must be in your name. This means that if you're not already a shareholder, you'll have to buy at least one share through a broker or a Drip service.

If you use a broker, you'll need to pay a commission on any initial purchase (more about choosing a broker is in Step 6). In addition, you'll have to specify that you want the share(s) registered in your name, not "street name." Brokerages routinely register shares in street name, meaning that when you buy stock through them, it's registered in their name. This is normally not a problem. It means that they hold the certificates for you and that makes it easier for you to sell quickly, without having to mail in certificates. If you do own some shares of the stock, but they're held in street name, you can pay a few dollars to have one or more of them transferred to your name.

Once you own a share or more in your own name, you can open a Drip account with the company and buy additional shares directly through the company (or its agent).

Direct stock purchase plans (DSPs) operate in much the same way, except they don't require you to own at least one share before enrolling. That's right -- you can buy your very first share through the program.

These Drips and DSPs vary a little from one to another. Some charge you a few pennies per share when you buy, most others (the ones we like best) charge nothing. Some permit automatic regular purchases, taking money directly from your bank account.

While many of these plans are great bargains, others might not be worth it, depending on your circumstances and their fees and policies. You need to examine the particulars of each plan you're interested in before deciding to enroll.

Advantages

Clearly, these programs are a blessing for those who don't have big bundles of money to invest at a time.

They're also wonderful in that they will reinvest any dividends sent your way. This can be a really big deal. Many investors don't appreciate the power of reinvested dividends. Let's look at an example.

If you'd held shares of Coca-Cola for the 18 years between 1981 through 1998, they would have appreciated a total of 4,718%. That's an annualized gain of 24% per year. (Who said enormous global companies are slow growers?) But wait, there's more! Here's the "secret formula" for investing in Coke: If you'd reinvested all the dividends paid to you into more shares of Coke, your total gain would have been 56% higher, at 7,364%. Annualized, that's 27% per year.

A $5,000 investment in Coke in 1981 would have grown to about $240,000 without reinvested dividends. With dividends reinvested, it would have become roughly $373,000. Impressive, eh?

Another advantage to these plans is that they permit you to slowly build up positions in stocks over a long period of time. This might not seem like such a big deal, but imagine that you really want to invest in Wal-Mart (NYSE: WMT), but it seems very overpriced right now. If you're a typical investor, not using Drips or DSPs, you'll probably wait on the sidelines for the stock price to fall a bit. If it never falls, you're out of luck.

But if you go with one of these programs and choose to invest small amounts of money in Wal-Mart each month or every few months, you establish a position in the company immediately and keep adding to it. If the stock price falls, your regularly invested amount will buy you more shares. (And you might even opt to send in more money than usual, to buy more shares.) If it keeps rising, the shares you already bought keep rising in value.

Another way to use Drips and DSPs is to buy all the shares of a company that you want at one time through them. For example, imagine that you want 100 shares of Citigroup (NYSE: C) and it's trading around $50 per share. You might spend $5,000 and buy the shares through a regular brokerage, or you might do so via a Drip or DSP. With the Drip or DSP, you can sign up for dividend reinvestment and enjoy boosted returns over many years. (Note that some brokerages now offer dividend reinvestment. See if yours does, if you're interested.)

Disadvantages

Every silver lining has a cloud, and these plans are no exception. A major drawback to them is the paperwork involved. If you invest small sums regularly in a handful of companies, you'll be receiving statements from each plan every time you invest. You'll need to keep everything very organized and record all your transactions for tax purposes. Taxes can get a little hairy when dealing with Drips and DSPs if you haven't kept good records. Fortunately, there is good software on the market that can ease some of the record-keeping hassles.

Another disadvantage, although it's not a major one for most Fools, relates to timing. Let's say you're convinced of the value of a stock and are eager to buy. Using a broker, you simply make a phone call or execute the trade online. Within minutes, you own some shares. But with dividend reinvestment plans, you usually have to send in a form and a check. This will take some time.

Also, many plans make all their purchases and sales only once a month, delaying things further. So you might not get into the stock exactly when you want, and you might end up paying a little more than you wanted for it (though sometimes you'll end up paying less). Similarly, when you want to sell a stock, it's not going to happen immediately. It might take a few weeks. For someone who's regularly sending in checks, perhaps every month, these delays don't matter. But be aware of them.

More information

There's plenty more to learn about dividend reinvestment plans and direct stock purchase plans. Start with our Fool's School section on Drips, which explains direct investing from A to Z.

The Fool's Drip expert Jeff Fischer demystifies the world of direct investing in his book, Investing Without a Silver Spoon, which provides everything you need to know about getting started. The book also gives details and contact information for more than 1,000 investment plans and a look at the industries and companies to strongly consider for direct investing.

A mother lode of information can also be found at Netstockdirect.com. This site lists details on just about every one of some 1,600 Drip and DSP programs. At Netstock you can download plan enrollment information, and you can also begin to invest directly online in 300 companies (and growing). Now that's convenient!

The National Association of Investors Corp. (NAIC), the country's authority on investment clubs, offers a Drip enrollment service, the "The Low Cost Investment Plan." For just $7 plus the price of one share of stock in any of the participating companies, you'll be enrolled and can then add to your shares regularly at little or no additional charge. You do need to be an NAIC member, however, and the annual fee is $39.

The Moneypaper website lists information on more than 1,100 companies that offer Drips. The site also offers the Temper of the Times enrollment service, which will purchase initial shares and enroll investors in Drips for a nominal fee.

Direct Stock Purchase Plan Clearinghouse is a free service that allows investors to order up to five prospectuses from companies that offer DSPs. (This is for direct stock purchase companies only, not Drip-only companies.)

One last resource to consider is our stock research newsletter, Motley Fool Income Investor, which focuses on investments that provide income, such as stocks with hefty dividend yields. Many of these could serve as prime candidates for Drip investing.

Now, on to our next stop on this Foolish journey... Step 6