Automatic DRIP

Can you tell me what DRIP investing is all about?

Dividend Reinvestment Programs, or DRIPs, are kind of like the pizza slices of the investing world: For those who don't have the cash on hand for a full pie, you can grab a slice at a fraction of the cost.

DRIPs, along with their siblings direct-stock-purchase plans, or DSPs, operate under a similar premise in that they allow investors to purchase a small amount of shares (even single or fractional shares) at minimal cost. They do so by offering "direct investing," which means investors can purchase stock from the company itself (or its transfer agent), rather than through a pricey broker.

We'll give you the lowdown on DSPs in a moment, but first let's talk DRIPs. Right now, more than 1,000 companies -; including big names like Walgreen (WAG), Pfizer (PFE) and most recently Microsoft (MSFT) -; offer DRIPs. Once a DRIP account has been opened, additional shares can be purchased outright from, say, Walt Disney (DIS), or from transfer agents like EquiServe, which handles DRIPs for big names like Nike (NKE) and Aetna (AET), often with no transaction cost. Dividends are also typically reinvested at no cost to the investor, which in itself can lead to sizeable account growth over time. Some DRIPs, like real-estate investment trust Sizeler Property Investors (SIZ), offer even more savings by allowing shareholders to purchase stock at a slight discount.

Getting started in a DRIP usually requires an initial investment ranging from a few bucks to $500. (That's a whole lot less than the account minimums required by most brokerages and mutual-fund families.) The other catch is that to open a DRIP, the investor must also own at least one company share in his or her name. For those who already have a brokerage account, this shouldn't be too big a deal. But for those who don't (and who don't want to open one because of the fees and minimum investment requirements), this can be a little tricky. One option is to buy a $30 annual membership at First Share, a network of investors who sell single shares of stock they already own to other members of the group. (You'll pay a small fee of $5 to $10 for each transaction.)

Sound like a hassle? Well that's where DSPs come in. These plans are like DRIPs, but they allow investors to purchase that first initial share from the company itself. Right now roughly 500 companies offer these plans, including Home Depot (HD), which has a minimum investment requirement of $250.

So what's not to like? Well, buying and selling DRIPs or DSPs hardly happens at the snap of a finger, notes George C. Fisher, author of "All About DRIPs and DSPs." Some companies, like Fifth Third Bancorp (FITB), execute trades only once a month, while others trade weekly. Some still trade on a quarterly basis. Programs administered by transfer agents, like the Bank of New York, J.P. Morgan Chase, EquiServe Trust or Citibank, commission sales over the phone, but take up to five business days to execute them. Needless to say, should a stock implode over a short period of time -; as we saw with Enron (ENRNQ) or WorldCom (WCOEQ) -; a slow-trading DRIP could turn out to be a real drag.

Selling shares will typically come with a flat fee of $10 or less, plus a small commission that's usually 15 cents or less per share. That may be more than you'd pay for a dirt-cheap discount broker, but since your purchases are typically free of charge, you'll still probably save money with a direct investing program. Nevertheless, this brings up a bigger issue with DRIPs, namely that it's absolutely essential that you understand all of the fees involved before you start participating in a program. Some plans will charge you when you purchase additional shares directly (not through reinvested dividends), others will charge you a small fee for automatic purchases you set up. Clearly you don't want to sign up for a program that's going to nickel-and-dime you all the way to the poorhouse. In that case you may be better off opening an account with a discount broker that will give you the additional luxury of selling shares whenever you darn well please.

Investing in DRIPs also requires careful attention to detail, since the tax implications of these accounts can get tricky. Under the current rules -; the president's dividend-tax plan would change things dramatically for the better -; investors must pay ordinary income taxes on dividends during the year they were issued, regardless of whether they were reinvested or not. Yet the real messiness comes when it's time to sell, since shares most likely have been purchased at different prices and held for different time periods. That can make calculating the cost basis complicated. Granted, each company will send its investors detailed quarterly statements and 1099-DIV forms at the end of the year for tax purposes. But for those with several accounts, the paperwork can be burdensome.

One way to stay organized is to use money-management software. Another option is to invest online through a DRIP broker such as ShareBuilder.com or BuyandHold.com. This can reduce your paperwork, since all of your accounts would be managed by one provider. Again, just be aware of the fees involved. ShareBuilder, for example, charges $4 per transaction, while BuyandHold charges $6.99 a month with two trades included and additional transactions at $2.99 each. These two offer unlimited purchase subscriptions as well, for $12 a month and $15 a month, respectively. True DRIP fanatics might find this to be the most cost-effective option, particularly since many DRIPs (such as Home Depot's program) have initiated transaction fees of $2.50 for all buys after the initial purchase.

For more on DRIP investing, visit NetStock Direct, which has a searchable DRIP database. DRIP Central offers a step-by-step guide to DRIP investing.