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MY BROTHER AND I recently reminisced about the investment club we helped found in the late 1980s. The club’s benefits were threefold: financial education, the pooling of money and camaraderie.
Our club was composed of family and friends. We met monthly. When we started, investing was largely a manual process. There were few discount brokers and even they charged relatively high fees. You bought and sold with a phone call, and mailed checks for payment. Meanwhile, many mutual funds had significant investment minimums that were above our modest means.
At the outset, we decided to invest half of our pooled money in blue chip stocks. To avoid brokerage fees, we started dividend reinvestment plans (DRIPs) with the companies we wanted to invest in. We eventually had accounts with Exxon Mobil, Merck, GE, Motorola and Ford. To set up these plans, some companies required investors to be an existing shareholder, meaning we had to buy at least one share on the open market.
Thereafter, the DRIP typically allowed us to purchase shares directly from the company involved, sometimes in amounts as little as $10. Many companies would sell us shares either commission-free or for a modest fee. We would also reinvest our dividends in additional shares. Some companies even sold their shares at a discount to the current market price, though this seems to be infrequent nowadays.
DRIPs were a great way to slowly accumulate shares of a quality company, offering a simple way to dollar-cost average into our chosen stocks. Automatic dividend reinvestment compounded our returns.
The downside of DRIPs included their tax treatment. Dividends were—and are—taxed in the year they’re received, even if you reinvest them. Also, selling can be tricky. DRIP shares are generally not marketable on the stock exchange. Rather, the shares are purchased and redeemed directly from the company. When our club sold shares, companies would often charge a fee of $5 to $15.
My brother and I discussed whether DRIPs still make sense today. With low- and zero-cost brokerage firms available, many of the barriers to investing are gone. Charles Schwab, for example, offers a basically free trading platform with no account minimum. When you purchase securities or funds, you can opt to reinvest your dividends.
Fidelity Investments and Vanguard Group offer similar services. And robo-advisors such as Betterment offer diversified portfolios with automatic rebalancing, tax-loss harvesting, dividend reinvestment and no investment minimum, all for 0.25% of assets per year. The day of the DRIP may have passed. But in its time, it was a valuable tool for those of us with modest sums to invest.
Thank you for the informative article. It got me thinking… I have a DRIP account for UPS with an administrator company, which takes a share of each dividend. I’d like to relocate the shares to fidelity and avoid the fee (or part of it). Would this require selling the shares (paying CG tax) and then repurchasing?
Mitch – assuming your Fidelity account is a brokerage account, I would ask about transferring the shares from the administrator company to Fidelity. I consolidated several DRIP accounts with my brokerage account at T. Rowe Price a few years ago and I didn’t encounter any issues with transferring the shares from any of the DRIP administrators. Just a little paperwork.
As you stated, many of the barriers to investing are gone. Many of the companies who sponsor a direct DRIP program have out-sourced the administration and record-keeping to companies that do a great job. The cost to buy and sell are usually pretty inexpensive, although with companies such as Schwab around, there’s really no need to start a DRIP account directly with the company anymore The requirement for brokers and mutual funds to keep and report cost basis information has been around for about 10 years now, I believe. All the brokers I have seen handle DRIP accounts pretty seamlessly. Determining cost basis is not quite the hassle it used to be.
Up until two months ago I used two DRIPS each for more than 25 years. Now I consolidated with a Fidelity account and still reinvest dividends.