Alexandria, VA (May 28, 1998) --While every rose has its thorn, the thorns on dividend reinvestment plans are usually dull and inconsequential to an investor with a Foolish mindset. Having covered some of the advantages of Drips yesterday, today we'll walk through the rose garden and brush up against some of the thorns.
The most frequent complaint that you'll probably hear is that many of these plans allow for the buying (and selling) of stock only once per month and on a set date, thereby precluding you from the opportunity to trade your stock at the exact prices that you want.
Though this is true in most cases, you're still better off investing methodically, every month or every quarter (three months), rather than trying to guess when is the right time to buy or sell. Most of the time you'd be wrong anyway. So, "disadvantage" number one is usually cited by people who think that they're better at consistently predicting stock prices than it is possible for anyone to be.
But this column is supposed to be about the disadvantages of Drips, not a defense of the so-called disadvantages. Initially, though, we want to point out that what are often called disadvantages in these plans can work in your favor over the long term. With any other disadvantages -- instead of simply citing them -- we'll offer a solution as well. Following are the disadvantages that you should keep in mind.
1. Set Buying and Selling Dates.
Best to begin where we left off. Most Drips have pre-set buy and sell dates and participants can only buy or sell stock on those days, meaning that you can't always act immediately on your instinct to buy or sell stock. As we just said, though, this is probably a good thing. You're meant to be a builder of long-term wealth with these plans, not a knee-jerk speculator. Most plans buy stock for shareholders every month. You'll become accustomed to, and even enjoy, sending your money every month and receiving your monthly statement. As Fools on our Web message boards have stated, "It gives a real sense of accomplishment every time I fire off another check to be invested." But do be aware of the limitations in buying and selling that these plans have. Each has its own system, and most are monthly.
2. Increased Record Keeping.
If you don't know how to start a filing system, then you should probably reconsider Drip investing. Making small regular investments and receiving dividend payments every three months means extra record keeping, especially for tax purposes. Dividends are taxed as income (as are brokerage commissions that are paid by the company for you). If you do sell any stock, you need to know what you paid for it in order to determine your capital gains taxes.
Luckily, Drip programs provide participants with an account statement whenever they make an investment, and usually a complete statement of all the investments made to date is provided at the same time as well. If not, a comprehensive statement certainly is provided at the end of the year, along with a 1099 statement that lists your dividend payments. Fools need to keep good records of these statements in order to stay on top of their Drip investments. We suggest that each time you open a Drip account with a new company, you start a file for it and keep all of the papers arranged in the file for as long as you own shares. Especially be certain to keep the year-end statements and to file your taxes accordingly, including accounting for the dividends received as income. By following the instructions that are given on the year-end Drip statements, you'll avoid a lot of confusion. If you keep good records, the process is not difficult and is little different than what regular mutual fund owners or even index fund owners must do.
3. Not All Companies Offer Drips.
Over 1,100 companies offer Drip programs, meaning that about 9,000 public companies don't.
The companies that do offer the plans, though, are naturally those that are more secure and well-established and are usually larger firms. Almost everyone can find a leading company that they know and respect and that offers a Drip program, be it Coca-Cola, Hershey, Johnson & Johnson, Carlisle Companies, or Caterpillar. But be aware that most small companies (including many high-growth companies) and those that don't pay dividends do not offer a Drip program. For those companies, you'll probably want to use a discount broker to buy shares. These is no reason that you can't open some Drip accounts and keep a traditional brokerage account as well, if you have the money and desire to do so.
4. Some Drip Programs Have Fees.
Fees: They sort of defeat the purpose, don't they? With discount brokerage trading costs declining every year, it doesn't make much sense to invest in a Drip that has 5% fees on every investment that you make with it. You'd save money by using a discount broker. Luckily, most Drip programs are still free, but be sure to investigate any costs involved before beginning a Drip with any company. Yesterday I mentioned General Electric as a great company with a dividend reinvestment program. Alas, though, I forgot that GE has begun to charge hefty fees. It's a shame.
The Drip Portfolio tries to avoid any companies that charge fees, and to date this has not been an issue. But if you do find a superior company and it has fees associated with its Drip, weigh those against the advantages that you'll gain by investing in it over the years. Don't preclude a Drip investment due to fees alone, but do think twice about it.
Finally, remember that almost all Drip plans do have fees for selling stock, but most are minimal and about the same as or less than if you were using a broker to sell.
5. Set Limits On Investment Amounts.
Though most Drips offer the opportunity to buy more stock every month, the amount of stock that you can buy usually has limits set on both the low and high-end. In Intel, for example, you probably know that when you invest you must buy at least $25 worth of stock and at most $15,000 worth of stock per month. As you can surmise, for most people these limits don't present a problem. While in Coca-Cola and several other plans, you can buy as little as $10 worth of stock per month (one of the beautiful things about these plans is the ability to send in so little money each month and buy fractional shares), and at most you can buy $125,000 worth of Coca-Cola per year. Again, we doubt that these limits will impede most investors.
So, those are some disadvantages and thoughts on them. If you have more insight to share, please visit the Drip Investing Basics message board.
-- Jeff Fischer