Let's say you find a company that would make a great investment, yet you don't have a huge amount of cash on hand. Or perhaps a young relative (e.g., a daughter or granddaughter) has shown an interest in owning stock, but doesn't think she can do it on a young person's salary.
The solution: dividend reinvestment plans, commonly known as "Drips."
Companies offer Drips as a way for their shareholders to buy stock directly from the company, in very small to large amounts. These plans get their name from the fact that they also reinvest dividends paid to purchase more stock. Thus, the name "dividend reinvestment plan." The specifics of whether you have to reinvest the dividends depend on the plan.
You don't need a large amount of money to start. In fact, owning one share is all that is required to enroll in a Drip. Many companies allow investors to purchase shares -- or even parts of shares -- through a Drip for nominal fees, or often no fee at all. These provisions, sometimes called stock purchase plans (SPPs) or optional cash purchase plans (OCPs), allow an investor to send in as little as $10 to $50 at a time to purchase additional stock. You can purchase stock every month if you like.
More than a thousand companies offer Drips, and some actually allow investors to purchase stock at a discount to the current market price. These discounts can range anywhere from 1% to 10%. Many companies also offer the option to make periodic Drip investments through automatic debits from bank accounts.
There are three kinds of Drips:
. Company-run: These are administered from corporate headquarters, normally as part of the overall shareholder relations effort. Some companies may even offer individual retirement accounts (IRAs) along with the Drip.
. Transfer agent-run: As managing Drips can be cumbersome, most companies turn to third parties, called "transfer agents." Because they can use the same resources for a number of customers, transfer agents can often provide Drip management services at a lower cost than the company could achieve by itself.
. Brokerage-run:Some brokerages will allow shareholders to reinvest dividends at no cost, even if the company in question does not have a formal Drip itself. However, these brokerage-run "simulated" plans apply to dividends only and don't permit optional cash purchases as most company-sponsored Drip plans do -- and optional cash purchases are a large part of what makes Drip plans so attractive.
The alternative to Drips is to use a service such as ShareBuilder.com. With these plans, you can make purchases of stocks for just a few bucks at a time. These services collect all the orders that people have made and purchase the shares of stock in a lump sum.
Drips are a great way to avoid paying brokerage commissions and to slowly build your savings over time.