Whitmore's Rules for DRIP Investing!

Prior to writing this week's column, I was trying to remember the first time I heard about the DRIP type of investments.

I must tell you, I am not all together sure, but, I think it was nearly 40 years ago when I was first working as a stockbroker for the then Paine Webber Jackson and Curtis. And I think it was in a training class (in those days you spent 6 months as a trainee before the exchanges let you take a broker's exam - can you believe that?!).

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As I recall, the instructor said something like, "Now, here is a twist that just might put you all out of business - the listed company sells its shares directly to your customer." And he let out a big laugh, as we all did, because it seemed so ridiculous at the time.

But today, many large companies offer, administer, or have their transfer agents administer what is called a Dividend Re-Investment Plan (DRIP).

The procedure is simple. Dividends paid to a stock owner are used to purchase more shares of stock in the company issuing the dividend. And there are now millions of investors that take advantage of this type of investing (wonder what my instructor would think of that?!)

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Now, if you are already one of those investors, you are aware that the original idea has grown beyond just the use of dividends as a re-investment tool. The story I hear goes that not too long after DRIPs began to be offered, several of the companies offering them decided why should the idea be limited to just the use of dividends to buy their stock.

"Let's allow investors to actually buy stock directly from us using their own cash," they said. Several companies today claim they were the first to do this, but who was actually the first to do it isn't important. What is important is that investors like you and me suddenly had a whole new way to buy stock. And it was just as simple as the dividend method and really, really cheap - most companies don't charge at all to sell their stock to us. So, today, the DRIP is joined by the SPP (Stock Purchase Plans). For as little as $5 or $20 or as much as thousands of dollars at a time, you can invest your cash in well over 1,000 companies using this unique method.

Over the years since they first appeared, some what I call general rules have evolved in the way these DRIP and SSP programs are run. Here is a quick synopsis of them:

Rule One: You will need to get a list of the companies that offer DRIP and SPP accounts. This can best be accomplished by going to our old, reliable backup Google. I entered "DRIP lists" and "DRIP companies" and both gave me a good number of web sites that present an alphabetized list of such companies.

Rule Two: Most, but not all companies, will require you become a registered stockholder before you can apply for their DRIP or SSP program - and most all will require you enroll in their plans.

Some of the companies even offer to help you become a registered stockholder by directly selling you a few of their shares. Others require that you come to them as an already bonafide stockholder before you can enroll. You will need to check this out for the companies you want to enroll in. Usually, this is information included in the Google lists. If you are required to be a shareholder, you might have no choice but to first contact a stockbroker to buy a few shares of the company whose plan you wish to join.

Rule Three: Some companies ask you to pay them an enrollment fee, usually a $5 to $15, from what I found. This is NOT the general rule, however, but be alert to it. If you do have a fee involved, I suggest that you be sure you buy as many shares at one time as you can to minimize the financial impact on the investment you make. For example, buying 3 shares of a $20 stock and paying a fee of $10 makes your real cost about $23 a share. If, however, you buy 100 shares, the average cost is only about $20.25 per share. So, be alert here.

Rule Four: The best way to invest, demonstrated by many investors over very long periods of time, has been to invest a fixed amount of your own money each month, with the dividend months representing a month where you invest your own regular monthly amount plus the dividend.

This technique has a name in the brokerage business. It is called "Dollar Cost Averaging." This technique is very different from the one used by many investors that try to "pick stock winners" or "time the stock market". These techniques have been shown, again over long periods of time, to produce far fewer truly successful traders than the dollar cost averaging method.

Without going into a long description here, basically dollar cost averaging says that by investing a fixed amount of dollars every month over 25-40 years leading to retirement, you buy shares at market highs and lows often enough that your average share cost winds up substantially lower than the investor that uses the "pick" or "time" method.

Interestingly enough, the dollar cost average investor also winds up with far more shares than other investors. This is mostly due to (1) the reinvestment of dividends over a long period of time, (2) the "extras" that the investor gets over the many years from "stock dividends" issued in addition to the cash dividends and (3) the unusual feature that "dollar" investors wind up buying more shares per month when the shares are lower in price. This lower price period is often when "time" or "pick" investors avoid investing thinking that the market will go lower. Thus, they often miss the best time to be buyers.

Rule Five: Whereas the early plans were administered only by the companies, there are now basically three groups that you will find administering plans. They are (1) the company administered plans, (2) the transfer agent administered plans (transfer agents are responsible for recording the movement of shares of a public company from a seller to the new buyer) and (3) the brokerage firm administered plans. This last one here might be called a "do it or die" strategy for brokers. They saw potential clients bypassing their firms and figured they would offer the DRIP and SSP plan themselves to try and keep these wandering investors.

My experience is the broker plans just add an extra layer of cost usually. However, to be fair, a few do offer genuine benefits, such as special monthly reports that help you overcome the job of recordkeeping for your DRIP or SPP, a potentially burdensome chore. Just take the time to check out ALL the fees such broker plans entail to be sure the benefits, for you, outweigh the cost of getting these benefits.

Lastly, here are a few of the cons to investing in DRIP or SPP plans. (By the way, I firmly believe the benefits of these programs, by far outweigh the cons.)

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1. The one to be most aware of, in my opinion, you must always pay taxes on dividends. If you reinvest all of your dividends (which I recommend), you will still have to pay the taxes and this may require you to come up with cash from other income you received during the year. This might be a problem for some that have built up large DRIP or SSP accounts.

2. Companies that offer DRIP and SPP plans do not guarantee investors that they will continue their plan forever. While I could not find records that showed any have discontinued their plans over the last 40 years or so, if one you are invested in one that did close down, you would need to find another company to replace the lost one in your portfolio. Just a little added work, usually, but be aware of this no guarantee feature.

3. Just because a company offers these plans, it does not mean that that company represents a "good" investment. Always seek to verify that any investment you make meets the criteria you have established as minimum requirements before you invest. (If you don't have such minimums, I suggest you take the time to establish a checklist.)

4. Lastly, my research seems to show that by and large you will be limited to investing in only the larger public listed companies. If you are a value investor, that is good. But, if you want to be doing some investing in the smaller up-and-coming companies, you will not generally find these offer the DRIP or SPP plans. For you, this might be considered a disadvantage.

A few final notes:

1. Some of the plans out there offer to have your monthly investment in the SPP plan automatically withdrawn from your bank checking or savings account. This can be a plus making sure you don't skip a month now and then and lose the full advantage of the dollar cost averaging investment approach.

2. Also, for those of you that like to use computer programs, there are several good ones offered on the internet designed just for DRIP and SPP investors. One of the better known names (thought understand this is an example, not an endorsement) is the Quicken software. Others can be found by "Googling" for them.

3. And finally, several hundred plans even allow you to purchase your shares at a discount from the market price, some as high as 8-9%, but most, from what I can find, in the 1-5% range. Absolutely take advantage of this benefit. It will only help magnify the dollar cost averaging benefits I spoke about above.

Well, that's about it for today. Hope you find the above of help to your income investing plans. And here, too, is hoping that your coming investment week is a good one. See you next week. In the meantime, keep in touch, I do!

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