The Danger:
Danger, greed, scandal, political intrigue. Brilliant women and intellectually drop dead gorgeous men. The stock market is for those gamblers who like to play inside of the law. Success varies from individual to individual. Some gain while others lose. Read the fine print. There are no safety nets and no guarantees. Investors put their money down to see what it can do for them which brings us perilously close to the first thrill of the Dividend Reinvestment Plan. It is dangerous to make assumptions about people you’ve never met but I’m going to assume that anyone who is reading this for information about Dividend Reinvestment Plans is: 1) American, 2) not independently wealthy, and 3) already taking advantage of all the tax qualified investment options he or she has.
The Disclaimer:
This isn't a 'how to' node. This is information. Not specific investment advice. I will not be held liable for anything anyone else chooses to do with their money. Now that that's out of the way I would like to introduce...
Dividend reinvestment plans
For those of you who have never been in the investment arena I have to warn you. This is hard core, seriously addictive, perfectly legal fun. But before we let those good times roll we need to get an account opened up.
Getting started:
Before you can open an account inside a dividend reinvestment plan you need to be a shareholder. A shareholder is a person, trust or institution that owns one or more shares of stock in a given company. One share of stock is all you need to participate in a dividend reinvestment plan. That single share can be purchased through a traditional investment firm or it can be purchased online. You will of course shop around for the best deal because it doesn't matter which company you buy your share from. The only thing that matters is that you've read the fine print including the fee schedule. I can not emphasize this enough because when it comes to investing there are hidden fees everywhere. Maintenance fees. Inactive account fees. Statement fees. Termination fees. No one knows how to charge fees like companies that have big expensive buildings sitting on prime real estate. That leads us to the first benefit of participating in a dividend reinvestment plan.
Fractional shares:
Dividend reinvestment plans offer investors an account that allows them to buy something you can't buy any other way. Fractional shares are parts of the whole and the only way to purchase them is through a dividend reinvestment plan. This is good because you as a new investor may not have much capital to invest in the market. What capital you do have should be defined in terms of purchasing power.
Dividend Reinvestment Plans mean more bang for your buck.
Accounts inside of dividend reinvestment plans help people save money because they take the stockbroker and their commissions out of the equation. Financial advisors are the middleman in the dividend reinvestment transaction. Your money should be working for you, not going to help someone else pay off their Lexus earlier. You want every penny of every dividend going into your account to purchase additional shares of stock. That is the essence of the dividend reinvestment plan. Buy a single share of stock and let the dividends accumulate while you go about your daily life. This brings us to another benefit of the dividend reinvestment plan.
Your money works for you even when you're not at work.
When you're hanging out at the beach you're soaking up the sun and earning dividends. Your dividend reinvestment plan is accumulating dividends as you eat, shower and sleep. Dividends drip into your account as you ride your bike into work. When you're sick in bed with a bad cold or spending time with that special someone, whatever it is you're doing that single share of stock is serving as the foundation for your divendend reinvestment empire.
Empire building:
Rome wasn't built in a day nor is a substantial investment portfolio grown overnight. Financial empires are built on dreams. The bigger the dream, the larger the goal, the more rewarding it is to arrive at the golden age of retirement. For that to happen your empire needs to be strong. You need to keep building it during times of adversity and you have to watch for threats to portfolio growth. Successful empire builders know that they need to keep an eye on the costs associated with growing their investment portfolio. This leads us to my next point.
Trading fees:
Costs reduce the size of any portfolio so we need to find ways to reduce those investment costs known as trading fees. A trading fee is what you will be charged if you'd like to purchase stock in any company. Traditional brokerage firms charge the highest fees, online brokerage firms charge significantly less but some dividend reinvestment plans want you as an investor so badly that they're willing to pay your trading fees for you. During 2007 I received $96.07 in dividends from a company whose stock I own. Trading fees for those transactions came to a grand total of six cents. I'd wager that just about anyone can afford six cents worth of trading fees but here's the best part of it all: that six cent charge was paid by the company and not by me which brings me to my next point.
Where your empire is housed makes a difference.
Some companies do nothing but manage dividend reinvestment plans. Some companies manage their own plans and some especially brilliant companies own the trust companies that manage their dividend reinvestment plans. Having a dividend reinvestment plan is different than owning stocks and having the dividends reinvested on your behalf. The distinction may not seem all that important but I can assure you that it is. You may assume that because a stock pays a dividend your brokerage firm will reinvest those dividends for you. This is not always the case. Some brokerage firms will reinvest dividends only if there are at least a hundred shares worth of a stock in the account and that does not mean owning 44 shares of Company A and 66 shares of Corporation B.
That means one hundred shares of the same company. Investors have to request that their dividends be reinvested or the dividends will sit in the cash position inside of your account. Reinvesting dividends means extra work for the brokerage firm. Some firms charge you to reinvest your dividends and this is where dividend reinvestment plans can help your empire grow. Reinvestment fees aren't always paid by the company whose stock you purchased but the trading fees for a dividend reinvestment inside a dividend reinvestment account are typically a fraction of what traditional and online brokerage firms charge. The bottom line here: the dividend reinvestment plan is going to help your empire grow faster.
Realize that a dividend reinvestment plan is possible.
Successful investing, in my opinion, has three key elements: faith, time and money. All three of these things are important and a lot of people think or feel that money is the most crucial of the elements but I would disagree. Buying securities carries a certain amount of risk. Your investment may lose value. You as a single share owner are handing your hard earned money over to a company that could go under. That's a scary thing considering no one I know has any money to burn and that's where the element of faith enters. There’s a certain amount of faith that goes into any investment. You may invest in friends only to have them turn on you. The company whose stock you purchased may discontinue their dividend reinvestment plan at any moment. All of life is risk but there are risks that carry their own rewards. Dividend reinvestment plans can be defined in terms of risk and reward.
Company failure is a risk but spinoffs are rewarding.
In preparation for this writeup I looked up an account of mine. In this particular account I have 85 shares of DFS. DFS is the ticker symbol for Discover Financial Services. In this account there is one transaction for the month of July. I have a deposit of $5.10. Now $5.10 is not a vast sum of money but here’s the beauty of it. I didn’t pay a thing for those 85 shares of DFS. Discover Financial Services was spun off from its parent company Morgan Stanley in 2007. Since I owned stock in Morgan Stanley I received one share of DFS for every two shares of MS I owned at the time. Morgan Stanley (previously called Morgan Stanely Dean Witter Discover) itself was a spinoff from its parent company Sears. Allstate Insurance was another spinoff. Companies spin other companies off and you as a shareholder benefit. That's one potential investment reward and our next topic leads us into another.
Stock splits:
When a stock splits the share price decreases and the number of shares increases. A two for one split means twice as many shares at half the price. It seems to be a purely mathematical transaction but things aren't always what they seem. The next time dividends are declared you have twice as many shares and that means twice as many dividends for your dividend reinvestment plan. You did nothing extra but you now have twice the shares collecting dividends. I don't know about you but that sounds like a pretty sweet deal to me. Those 85 shares of DFS have made me a couple dollars richer. I wish that I had purchased more Morgan Stanley stock when I could have but I was like a lot of other people. I was reluctant to add to my empire in a time of economic hardship.
Time is money. Delay not.
As the world turns the economy sinks and peaks. You have bills that need to be paid. You need food, clothing, and shelter. My guess is you will still need these things when you retire. The smart empire builder puts away small sums of money even when times are tight. Dividend reinvestment plans are for the empire builder. They're not for people who are in the market to get rich quick. Dividend reinvestment plans are for investors who are in the market for the long haul. These plans won't immediately gratify you and I know from personal experience that it is agonizing to see how slowly your shares and dividends accumulate.
If patience is a virtue dividend reinvestment plans require you to be virtuous.
Empire building takes time and my earlier examples of dividends I've earned are fairly respectable amounts only because I used to work at Morgan Stanley. I have one dividend reinvestment account that gives me twenty-four cents every quarter. Two cents goes to the trust company to cover the cost of the trade and twenty-two cents gets reinvested. That twenty-two cents is all that's being reinvested but here’s where risk and reward enter back into the conversation. I’m not risking very much of my money. I don’t have a lot invested into that company and this isn’t always the case but there are instances where risk is commensurate with reward. The more of my money I risk buying stock the more dividends I accumulate.
Deciding to set up a dividend reinvestment plan is easy. Deciding which stock to purchase is a little tougher. When you go online to look up which companies offer dividend reinvestment plans you will see a big long list of companies. How do you know which one is a good investment?
I’m assuming that you don’t have large amounts of money to invest in several different companies. I didn’t when I first started out. I still don’t but that doesn’t mean that the company you choose to invest in doesn’t matter or more importantly that you should put it off until you think you can afford it.
Time in the market is more important than the timing of the market.
Look through the list of companies that offer dividend reinvestment plans. See if there are any names you recognize. See if there are companies whose products or services you buy and do your research. Make sure that company is in good financial health because no matter how little that first share costs you'll be (theoretically) hanging onto that share and continuing to add to that account. Every time someone cracks open a can of Coca-Cola I feel a little bit better about those shares of Coke sitting in my dividend reinvestment account. I didn't have much money to spend when I bought my first share of Coca-Cola but I went ahead with the purchase because Coke was a company that had what I was looking for when I began investing. I have more money now than I did back then. Part of that is because I started investing when I was young and this is the key here people.
Start now because now is the time.
I won't bore you with statistics because in my opinion statistics are not a good way to motivate people. We all know what we should be doing. Doing it is a different matter. The following idea isn't a statistic it's a hypothetical situation and I think it illustrates the cost of waiting to invest. To start we have two hypothetical investors that are the same age. Investor A invests for ten years before quitting. Investor B waits until after Investor A quits to start investing. Assuming the same rate of return and the same investment portfolio Investor A comes out ahead in the long run even though Investor A put less money in the market. That's a pretty powerful statement but I've seen young people give that sheet of paper a half-hearted glance before walking away. I've seen older people give it a longer look before refusing to sign on the dotted line. I've met people who wish that sheet of paper would have been in front of them at some previous point in time. Now you know something they didn't and here's another thing you may not have known.
You can start a dividend reinvestment plan with less than thirty dollars.
Liz Claiborne, ticker symbol LIZ, is currently priced* at under fifteen dollars. For less than forty dollars you could have two shares of Liz Claiborne in your portfolio earning dividends and that's just one of the stocks out there with a dividend reinvestment plan option. I can't offer anyone specific investment advice. I'm not recommending anyone purchase any shares of anything but the fact remains that your initial foray into the investment arena doesn't have to start with large amounts of money.
What happens when you purchase a stock that goes down?
Buying stocks is just like buying most commodities. When the price goes down, you can buy more with the same amount of money. Morgan Stanley is currently right around $45/share. It's been below $30/share and as high as $107/share. Assuming that Morgan Stanley is an investment that meets my needs and I've done my research, all the price fluctuations mean is that my $96 worth of dividends is buying two shares of stock instead of some other amount. As long as your stock is still a good solid company that helps you meet your investment objectives I don't believe there is a reason to sell even in a bear market. That being said there are reasons to sell and as much as I like dividend reinvestment plans as an affordable investment option they do have their disadvantages.
Selling your stock:
Because there is no broker managing your account the dividend reinvestment plan does not function like a brokerage account. You can't pick up the phone and tell your broker to sell everything. What you can do is read how your specific plan works to find out how sales of stock are processed. Some plans accept sell requests at any time but process them only quarterly. Other companies handle things differently. Given the number of companies and the number of plans I can't offer you any more specific information than what I've already given you. Know your account. Familiarize yourself with the policies and fee structures and realize that one of the disadvantages of the dividend reinvestment plan is your money may not always be as accessible as you might wish.
Systematic investing:
The stock market is a fickle and flexible beast. Up one day, flat the next. It can be an emotional roller coaster watching your stock test the fifty-two week limits. The important thing to remember here is that until you sell your gains/losses are all on paper. Investing should not be an emotional decision. It should be a rational one and another way that the dividend reinvestment plan helps you as an investor is it allows you to take advantage of dollar cost averaging. The writeup in the dollar cost averaging node does an excellent job explaining the process so I won't reiterate that information here. What I will do is tell you something I've observed. People who wait for the perfect day and time to purchase a stock are still waiting. Empire builders aren't afraid to start small. They're not afraid to take small calculated risks and they realize that there's no time like the present to start investing.
Which companies offer Dividend Reinvestment Plans?
Typically the companies that offer dividend reinvestment plans are large cap, blue chip companies that have been around for years. Household names such as Nike, Harley Davidson and Johnson & Johnson. These companies can afford the administrative expense of running a dividend reinvestment plan and keep in mind that it’s in their best interest if you participate in their dividend reinvestment plans. By allowing individual investors to set up dividend reinvestment plans the company that owns the stock doesn’t have to spend time or money mailing out dividend checks. They have instant access to capital via your investment and when it comes time to pay your dividends they make an electronic transfer of stock from their account into yours. This might sound minor but when your company is worth billions, you have massive market share and millions of people own your stock, the amount of cash needed to cover a quarterly dividend pay out is significant.
How do I know if a company is in good financial health?
One of the more boring parts of investing is reading financial data. I feel that everyone should familiarize themselves with basic accounting procedures so they can read income statements and balance sheets. Financial statements are the tools an investor uses to evaluate whether the company they’d like to invest in is a healthy one. No one thought the Titanic would go down and no one thought companies like Arthur Andersen and Enron would fail either. Nothing is guaranteed in life. The companies that you invest in could be here today and gone tomorrow. Even companies like Home Depot, General Electric and, God forbid, Morgan Stanley.
Dividend reinvestment plans require you to do some research. It means you have to sit down and think about what kind of purchase you’d like to make and for dividend reinvestment plans to really pay off you need time. Time is on your side when you reinvest your dividends. Your reinvested dividends are going to be purchasing miniscule amounts of stock. You have to pay taxes on your dividends (this assumes stocks are held in a non-qualified plan) and you’re paying taxes but you’re deferring the right to that money with the hope that some day the dividend reinvestment account you started way back when will pay off.
Do dividend reinvestment plans pay off in the long run?
The answer to that is it depends. It depends on when you start and what companies you invest with. Diversification is the key to a balanced portfolio and fortunately there are dividend reinvestment plans for companies in almost any market sector you can think of. Some companies will even give initial investors a discount to buy their stock provided you hold it in their dividend reinvestment plan. Those are the smart companies. They want your money and they’re willing to give you an incentive to invest with them.
I started this writeup talking about retirement plans and I'd like to go back to qualified plans for a moment. Some dividend reinvestment plans allow people to open Individual Retirement Accounts. None of the concepts introduced in this writeup are beyond the scope of anyone reading it which is one of the reasons I get so frustrated talking about things like this. People will spend hundreds, maybe even thousands of dollars doing things like going out to eat or shopping at the mall before they’ll invest one red cent into an investment account. I can tell you horror stories of people who waltz into brokerage firms with a couple stock certificates thinking that their retirement needs have been met. I’ve seen those same people in shock when they realize that their money isn’t going to cover what they had planned on it covering. Don't be that investor!
Consider opening a dividend reinvestment account if you haven't already.
Dividend reinvestment plans are the bargain shopper’s way of investing. They’re for the thrifty, the frugal, the prudent and the shrewd. Savvy investors are the ones who know where their money goes. They’re careful with it. They read up on the companies they’d like to invest with and they subscribe to the pay yourself first theory. When it comes to money and investing greed is good. You’re risking your hard earned money here and you should be rewarded for that.
A quick review:
We’ve established that opening an investment account is simple and easy to do. We’ve reviewed some fun facts about dividend reinvestment plans and I’d like to leave you with one final homework assignment before you go back to reading The Wall Street Journal or your country’s equivalent. The Motley Fool has excellent investment advice and if you don’t believe that dividend reinvestment plans pay off in the long run I’d like you to read the following: article. Read that and think about how many people are opening cans of Campbell's soup. As always, caveat emptor, but if there’s some gambler in you think about picking up those investment dice. Let the good times roll.
Sources:
The Motley Fool www.fool.com
Investopedia www.invsestopedia.com
Share Builder www.ShareBuilder.com
Thanks to Tem42 for the nodeshell.