Understanding the DRiP

Dividend Reinvestment Programs allow one to easily build their position in a company by automatically reinvesting dividends.

Many of us go through a phase where we understand how stocks work, we understand some of the factors that contribute to the increase or decrease of the stock’s price and therefore feel that we can anticipate these changes and start trying to time the market. In the late 1990s, we were all geniuses and in the early 2000s, we were all idiots.

I started investing in Dividend Reinvestment Programs in the early 1990s and a decade later came to realize that although I survived the fall of the Internet stocks in the early 2000s, simply finding great companies and making regular investments probably would have been the more lucrative route.

Companies that offer dividends know that it is to their advantage to retain their investors. This is one reason they might offer a Dividend Reinvestment Program. A Dividend Reinvestment Program is one where purchases of stock can be made without going through a DRIP broker, and the dividend one receives is used to purchase the company’s stock. For example, instead of receiving a $10 dividend check, one would have that $10 used to automatically purchase as much stock as that amount would represent.

This normally results in one owning partial shares. For instance, 3M’s current stock price is $170.09. Instead of receiving a $10 dividend check, one would have 0.058 shares (10 / $170.09) added to their holding.

At first glance, this does not seem like much, and indeed it is not. Looking at my purchase history of 3M I see numerous dividends being converted to partial shares in this range. I did make somewhat regular purchases through the years but today a bit over 30% of my holdings of 3M were obtained through the reinvestment of dividends.

It should be noted that some companies are charging for this service. At one point I had a DRiP set up with The Coca-Cola Company. I would send a check for $50 which was used to purchase $50 of stock, and my dividends were converted to stock without charge. I no longer own shares in the company partially because they decided to start adding fees to the DRiP.

Computershare administers KO’s DRiP and below are the charges from their website.

This hardly makes it worthwhile to participate. A $50 purchase is immediately decreased by more than 6% through fees, and reinvestments similarly have a chunk taken off the top. This means that the values of the stock needs to rise accordingly just to get back to even.

Fortunately, there are over 200 companies that offer fee-free DRiPs, meaning that you pay to have things set up and you pay to sell shares, but purchases and reinvestment are without cost.

In the next article, I will delve into what I see as the first step in selecting companies that will offer you dividends for decades to come.