Tags: Dividends, DRIP Stocks, Investing Strategy

Ramp Up Your Portfolio's Growth with Dividend Reinvestment Plans

By , Contributing Writer, Money Morning •

With interest rates near all-time lows and equity markets in flux for much of the past decade, dividends have become an increasingly attractive feature for stock investors. But, while it's always nice to receive those quarterly checks, dividends do little to help you grow your wealth if all you do is spend the money as it comes in.

If that's your approach, it's regrettable because an array of financial and academic studies have shown that dividends have accounted for more than 60% of total U.S. stock market returns since 1870. In fact, research reported in the book "Triumph of the Optimists: 101 Years of Global Investment Returns" found that over the course of the 20th century, a portfolio with dividends reinvested would have generated nearly 85-times the wealth of the same portfolio relying solely on capital gains for growth.

Fortunately, it's now quite easy to take advantage of the growth potential offered by regular corporate payouts to shareholders, thanks to the proliferation of so-called DRIPs - or dividend-reinvestment plans.

DRIPs are special programs sponsored by corporations that allow shareholders to immediately reinvest their dividend payouts in the company's common stock, usually without brokerage commissions or fees, and often at a discount to the current market price. Most company-sponsored DRIPs have a minimum of just $10 for reinvestment and allow accumulation of fractional shares, meaning even small stockholders can participate.

At last count, more than 1,100 U.S. corporations sponsored their own DRIP programs, including such major names as Goodyear Tire & Rubber Co. (NYSE: GT), Yahoo! Inc. (Nasdaq: YHOO), Texas Instruments Inc. (NYSE: TXN), The Hershey Company (NYSE: HSY) and many others.

In addition, some brokerage firms and numerous DRIP advisory services will set up and manage dividend-reinvestment plans - known as "synthetic DRIPs" - for shareholders of leading companies that don't offer plans of their own, as well as for many of the top exchange-traded funds (ETFs). (Note: Virtually all regular and many closed-end mutual funds offer automatic dividend-reinvestment plans for their shareholders.)

The major advantage of participating in a DRIP program is that it provides low-cost compounding of your investment dollars. That enables you to accumulate more shares and increase the value of your position at a faster rate, even when the price of the stock itself doesn't do as well as you might have hoped.
It pays to be a DRIP

For a two-scenario example that illustrates this point, check out the accompanying chart. As you can see, by participating in XYZ Corp.'s DRIP, you've accumulated 43.75 additional shares, upping your quarterly payout by more than $15 and lifting the total value of your position by $1,750.08 - even though the stock price ended up exactly unchanged from two years earlier.

Other DRIP advantages include the ability to acquire fractional lots - and even fractional shares - rather than having to wait until you have enough money for a round lot or full-share purchase.

In addition, most companies with DRIP programs also offer what are known as "direct-stock investment plans" (DSPs). These allow existing shareholders to make purchases of additional shares directly from the company, in small or large quantities, again without a commission or other fees. They also provide many ancillary services, such as Individual Retirement Accounts (IRAs), monthly or weekly purchase plans, and telephone redemptions.

(Note: More than 600 companies also offer so-called "no-load" stock plans, which allow you to make your initial share purchase directly from the company, without commissions. However, many of these plans are restricted - often to company customers or residents of the corporation's home state.)

Of course, DRIPs also have a few negatives, but these fall mostly into the category of inconveniences rather than actual threats to your investment success.

For starters, most corporate DRIP plans require you to become a "registered shareholder" rather than a "beneficial shareholder." That simply means you must be a direct owner of the company stock and listed with its transfer agent rather than having your shares held by your broker or other proxy in so-called "street name." In the past, this meant having to receive and safeguard the actual stock certificates, but today almost all direct ownership is handled via electronic bookkeeping entries, with no certificates needed (unless you want them).

Another irritation is that, even though you don't actually withdraw your quarterly dividend payments, the IRS still requires you to pay taxes on them in the year they are received.

Perhaps the most onerous inconvenience is the need to keep track of the cost basis for each of the many small share purchases you make when you reinvest your dividends. You'll need this information to calculate your capital gains and your tax liability when you eventually sell the shares. This doesn't sound like a major problem since you only get four dividends a year, but if you use DRIPs on 10 stocks for five years, it adds up to 200 small purchases you'll have to account for when you sell. You'll also have to make multiple adjustments in the event of stock splits, spin-offs or mergers.

Sounds like a headache - and it is. But the benefits of DRIP investing in terms of growing your wealth far outweigh the inconveniences.

If you want to know whether a company whose stock you already own (or are interested in buying) offers a DRIP plan, you can contact the Shareholder Services or Investor Relations department of the corporation. Numbers and addresses are available in the company's annual reports, at its Web site, or in the "Profile" section of most online quote-service listings. They'll be happy to advise you regarding the availability of DRIP, "no-load" or DSP purchase plans and what you need to do to enroll.

If the company itself doesn't sponsor a plan, you can also check with your broker to see if his or her firm supports a synthetic DRIP program for clients, or you can check with one of the leading DRIP advisory firms, all of which can quickly answer your questions, advise you regarding fees and help you open an account. You can get contact information for five of the top DRIP services by clicking on the following links:

Using a DRIP won't give you the potential for big overnight gains, but with time and compounding, even little DRIPs can grow into a big pool of wealth.

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