The Downside of Drips
Seven of them. Like the Seven Sins?

by George Runkle (TMFRunkle)

Atlanta, GA (August 2, 1999) -- In the past week or so on the Drip board, there has been a lively discussion about the pros and cons of Drip investing. Granted, I am a rather biased person on this, since good portions of my personal investments are in Drips, and I do write this column every Monday. However, there are a number of reasons why a person may not want to invest in Drips, so I'd like to go through them here. I'm going to start with what I consider the least important of the negatives, and work up to what I feel are the most important things to consider (all the while sharing my thoughts on each). Here they are:

1. You cannot time your purchases or sales to match the high and lows of the stock.

That said, the Fool of course has serious doubts about market timing, and waiting for a stock to drop a point or two may cause you to miss a purchase. Or, you might just buy a stock on its downward slide to oblivion. Likewise, selling at what you consider a high may be only one point on the way up. So, trying to time the market isn't advised anyway.

2. The fees can cost you more than a discount broker.

This depends on how much you are investing at one time and the Drip program you are considering. I invest $50 a month in Johnson & Johnson (NYSE: JNJ) electronically, and the transfer agent charges me a $1 fee each time. That's a 2% fee, which isn't too bad. It would be hard to find a discount broker that will do that for me on $50 a month. However, some plans have outlandish fees, and if you are investing over $400 at a time, a deep discount broker may be better suited for you.

3. Selling can be difficult.

Again, it depends on the plan. The worst plan I ever had didn't sell the stock, they would send you a certificate. You had to arrange for the sale yourself. On the other extreme, many plans will sell stock for you on the first business day after you call to request the sale. It's not as fast as a brokerage, which will sell the stock immediately. Surprisingly, though, when I sold some of my Coca-Cola (NYSE: KO) position last summer to buy my house, I received the check about four days after I called First Chicago to sell it. I sold a stock in a brokerage account my son had, and it took over a week to get the check. The brokerage waited three days until the trade had settled to send me the funds.

4. Purchases are often on a terrible schedule.

My son has a Norfolk Southern (NYSE: NSX) Drip, and they purchase four times a year. You have to send them a check in a narrow window of time prior to the investment, which I am consistent at missing (they have no automatic purchase option). Other Drips invest more reasonably, on a monthly or better basis. It's important to check the plan.

5. It's not possible to buy the younger growth companies.

Amazon (Nasdaq: AMZN), America Online (NYSE:AOL), and many of the other really strong performers do not have Drips. Generally, only more mature dividend-paying companies carry these plans. I make use of my brokerage account to purchase these other issues (and I have done much worse than my Drips).

6. Recordkeeping is a nightmare.

In a word, yes. You have to keep meticulous records, otherwise you will pay a fortune in capital gains when you sell. With monthly purchases and fractional shares, this is not easy. I use Quicken to track my Drip accounts, but it takes up time every month to enter the statements, and it is a real hassle. My brokerage account is much easier -- although I also use Quicken to track it, I don't have monthly purchases of fractional shares to enter when the statement comes.

7. Taxes are even worse.

If you sell any of your Drip positions, you are in for a real treat come tax time. You have to account for the price of every share sold, which is even less fun with the fractional share purchases every month. Then you get to figure if they are long term or short term. All this is on the dreaded Schedule D, which will be pages and pages of fun if you sell a significant position. I've used Quicken and TurboTax to do this, but it still requires meticulous data entry (as stated in #6). Even though I used these programs, the whole process left me feeling slightly uneasy, and dreading an audit where I'd have to explain each purchase and sale. Root canals are more fun -- at least the dentist will give you laughing gas.

Consider your own situation, and look at any plan you intend on entering very carefully. Figure in its fees, how difficult it is to sell, and how often it will let you invest. Does it have an automatic purchase option? How fast does it sell when you are ready to pull out? How much money do you have to invest? If it's a significant amount each time, compare the plan fees with a discount broker's commissions -- it may not be advantageous for you to Drip. Finally, do you want to do the recordkeeping? You may find that a Drip isn't good for you.

To discuss Drip investing with others, please visit the message boards linked in the top right of this page. Fool on!

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