By Randy Neumann
I love English grammar. I attended a Catholic grammar school where the nuns taught us, among other things, how to diagram sentences and the difference between transitive and intransitive verbs.
I recently looked up the word “drip” in my Random House Webster’s dictionary and read the following:
· Intransitive verb (v.i.) – a verb indicating complete action
1. to let drops fall; shed drops: This faucet drips.
2. to fall in drops, as a liquid; dribble
· Transitive verb (v.t.) – a verb accompanied by a direct object that forms a passive
3. to let fall in drops
· Noun (n.) – a word used to name a person, place, or thing
4. an act of dripping
5. liquid that drips
6. the sound made by falling drops: the irritating drip of a faucet
7. Slang – a boring or colorless person
I know you’re thinking, “I thought this was a financial column.” It is. Now, we can add an additional meaning of the word drip. DRIP is an acronym for a “dividend reinvestment plan.”
According to Wikipedia, “A dividend reinvestment program or dividend reinvestment plan (DRIP) is an equity investment option offered directly from the underlying company. The investor does not receive quarterly dividends directly as cash; instead, the investor’s dividends are directly reinvested in the underlying equity. The investor must still pay tax annually on his or her dividend income, whether it is received or reinvested.”
This allows the investment return from dividends to be immediately invested for the purpose of price appreciation and compounding, without incurring brokerage fees or waiting to accumulate enough cash for a full share of stock.
Since stock dividends average a little below 2% of the share price, you cannot buy even one share with a quarterly dividend, unless you hold a lot of shares. Not to worry. Most companies let you buy “fractional” shares. The dividends purchase small “pieces” of a stock until you have enough to own another share of the stock.
One benefit is that you save any brokerage fees on the transactions. Instead of going through a broker to buy the stocks, you buy directly from the company through the DRIP method. The benefit to the company is that it receives a steady cash flow from existing shareholders. Most companies charge a nominal registration or enrollment fee to get into the program.
Another advantage to the investor is that you get the benefit of dollar cost averaging (DCA). DCA is one of the wonders of the world because, as the price of a stock goes up and down, you buy more shares when the price is low and fewer shares when the price is high. At the end of a time period, you have purchased your shares at less than the average cost of the shares. This is a good thing. (Such a plan does not assure a profit and does not protect against loss in declining markets.)
As we all know, there is no such thing as a free lunch. DRIPs have their drawbacks as well. First, they create a record-keeping nightmare. Reinvesting small dividend amounts over a number of years may complicate the process of determining your cost basis, capital gains, and taxes due whenever it comes time to sell those shares. Additionally, as the fruit of a rotten tree is rather unappetizing, shares of stock in a lousy company are equally unenticing. You must stay on top of what is going on with the company from whom you are DRIPping.
Another drawback is that although you are reinvesting the dividends, Uncle Sam deems you to be in receipt of them as income, so you will have to pay tax on the dividends even though you did not receive the cash. But this is not a major drawback.
One strategy for safely investing comes from diversification. A properly diversified stock portfolio should have a minimum of 30 stocks representing a broad perspective of the market. No, you don’t have to be a millionaire to have a broadly diversified portfolio of DRIPping stocks because most companies require you to own only one share, although some companies may require that you have a certain number of shares as a minimum.
To start DRIPping, you’ll need to enroll in the company’s program. Contact the company’s shareholder relations department for a DRIP application and prospectus, which will give you all the information you need about the plan.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual. Randy Neumann CFP® is a registered representative with securities and insurance offered through LPL Financial. Member FINRA/SIPC. He can be reached at 12 Route 17N, Suite 115, Paramus, 201-291-9000.