Investing isn’t easy. If it was, everyone would do it. In fact, 65 percent of Americans save little or nothing, according to a Bankrate survey.
Unless you’re knee-deep in stock market lingo, knowing how and when to buy and sell stocks can be intimidating. So much, in fact, that it could keep consumers from taking that first step into investments.
Those looking for a no-hassle way to grow their money don’t have to sit on the sidelines. With dividend reinvestment plans, known as DRIP investing, you can take full advantage of the power of compounding — without much work, money or knowledge about investing.
What are DRIP investments?
DRIPs are investment accounts in which you buy shares directly from a company and then reinvest the dividends back into more shares. Dividends are periodic payments that companies make to shareholders from the company’s earnings or reserves.
Their major appeal? DRIPS are accessible and easy to start and with many there are no brokerage commissions. Most Standard & Poor’s 500 companies (companies that account for the majority of the stock market’s capitalization) offer DRIP accounts. A few examples include Honeywell and Aflac.
“This would be a very good, deliberate way of setting aside money that might otherwise flow into something else and be spent,” says Frank White, PNC Wealth Management Investment Market director for greater Washington. “And it’s just one more way that you’re making sure you’re capturing as many dollars as you can so that you have those dollars in retirement down the road.”
Some companies offer flexible options for DRIPs, like full or partial reinvestment. Those who want a steady flow of money into their checking or savings account can opt to have a portion of their dividends go there instead of reinvesting them in full.
DRIPs work on a dollar-cost averaging basis. Under this technique, you buy shares throughout the year at various prices, more of them when the share price is low and fewer shares when it’s high. The idea is to pay a lower average price per share over time.
Some companies even offer DRIP shares at a discount from the current share price. These advantages can get you a better return than if you had bought the same shares on the open market.
Note that since you won’t always reinvesting a full share, you might have fractional shares in your account. White notes that some institutions only manage whole shares on their books, so it’s an important factor to look into before deciding which brokerage will hold your shares.
The power of compounding
White praises DRIPS because of their power of compounding. This means that over time, any gains on your investment will be rolled into still more shares and more gains on those shares and so on.
Through buying shares directly with the company, broker commission fees generally get skipped, and all of the money earned gets reinvested.
According to Dividend.com, an initial $2,000 investment in Pepsi in 1980 would have started an investor with 80 shares. By the end of 2004, those shares would have skyrocketed to 2,800, worth more than $150,000, thanks to reinvested dividends.
Picking a company and getting started with a DRIP
Getting started with a DRIP account requires a bit of research. White recommends investors look into three main points: does the company pay dividends? Has it had a consistent history of doing so? What is the company’s history of raising them over time?
If you’re unsure of where to start your search, White recommends looking into the Dividend Aristocrats. These S&P companies have a record of increasing dividends for 25 consecutive years or more.
To start a DRIP account, consumers can directly contact investor relations at the desired company. If the company, like Apple, doesn’t directly offer a DRIP program, but pays dividends, investors can work with a broker to set one up, though it would lack some features of a company-sponsored plan.
As with all income, dividends are taxable. White says it’s imperative that investors take the appropriate steps to pay taxes on them. He recommends investors put money aside, in a separate account, so they’ll have the cash on hand to pay their tax bill.
Qualified dividends, which meet certain IRS requirements and are held for a certain period, are taxed at a lower rate than ordinary dividends — usually around 15 percent. This could be lower than the federal tax rate for an investor’s other sources of income.
As with any investment, DRIPs come with the risk of loss. Investors looking for assistance with specifics of their own accounts should contact an investment advisor.