Some of the biggest financial scams in history had the simplest pitch: They offered something for nothing. Smart investors have learned to be skeptical of investments that make those offers.
But many companies offer a legitimate, simple way to get what amounts to free money. And it couldn't be easier to claim your share. All you have to do is buy stocks and reinvest the dividends.
Earning profits, drip by DRIP
Millions of investors have discovered the long-term power of dividends. By buying a stock and reinvesting the dividends into additional shares of the company, you'll see your total position in the stock soar over the years. For truly long-term investors, the gains from reinvesting dividends often dwarf what they realize from their original shares.
But to find the free-money opportunity with dividend-paying stocks, you have to go back to an older method called the dividend reinvestment plan. It may seem old-fashioned, but these plans, also known as DRIPs, can help make your dividends work harder for you.
Here's how it works: After you enroll in a DRIP, you can arrange to have all your dividends reinvested in shares every quarter. DRIPs typically have rules that determine the per-share price you'll pay on those reinvested dividends. That makes DRIPs extremely convenient because the reinvestment happens automatically.
But even better, some DRIPs give you a discount on the shares you purchase through reinvested dividends. Before you get too excited, the discount usually is fairly small -- between 1% and 5% of the dividend amount. But the discount still represents money that you're saving versus going out and buying the shares yourself -- and even brokers that offer dividend reinvestment services of their own won't give you those discounts.
Who's giving away the free money?
Obviously, not every company offers these discounts. But many companies do. Here's a sample:
Current Discount Available on Reinvested Dividends
Piedmont Natural Gas
Health Care REIT
Penn West Exploration
Source: Company investor relations.
Why would companies like these let you buy shares at a discount? One reason is that encouraging dividend reinvestment saves companies the expense of cutting checks for small investors. If a DRIP discount encourages you to reinvest those small amounts every quarter, then the company benefits from lower costs.
Another reason is that the move can generate demand for shares without costing very much. Because large institutional investors aren't going to accept the rules and conditions of a DRIP -- rules that encourage long-term investment over short-term liquidity -- it's not as though the company has to worry about hedge funds or other massive investors using DRIPs to siphon millions of dollars from their coffers.
What's the catch?
DRIPs can be very useful tools, but they do have limitations. For one thing, many DRIPs require you to already be a shareholder of the company to participate. That means that you have to find a way to buy your initial shares of stock before taking advantage of the DRIP. That used to be prohibitively difficult, but again, discount brokers and commissions of $10 or less make buying those first shares a lot less painful for your pocketbook.
Also, some companies charge fees to participate in their DRIPs. So don't assume that any DRIP is automatically a good deal -- even if it offers a share discount on reinvested dividends -- until you check the plan's fees. In some cases, those fees could partially or even completely offset any benefit from a discount.
For the most part, though, DRIPs offer a great way to help you build up a substantial position in dividend stocks. The ones that give you free money make the value of compounding even sweeter over the years.
Discounts are great, but you still want to make sure you have the best dividend stocks in your portfolio. We've put 11 of the strongest in this free special report from The Motley Fool; with thousands of readers having already discovered them, you shouldn't wait another minute to find out about them.
Editor's note: A previous version of this article included a company that has a discount DRIP in place but pays no dividends at this time.
Fool contributor Dan Caplinger wishes he could buy all his shares at a discount. He doesn't own shares of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Health Care REIT, Piedmont Natural Gas, and Aqua America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy doesn't think you're a drip.
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