DRIPs- Buy Stock Direct (for free?)

I posted yesterday about my forays into buying stock. One of the cheapest ways to do so through a company's dividend reinvestment plan (DRIP or DSP). It's how I bought BP, and I own Johnson & Johnson, Pfizer, Costco, and my personal favorite, the Cubes- the NASDAQ 100 index (QQQQ). Direct reinvestment plans are not for market timers or short term investing. It's great for people who only have a little chunk of change at a time and want to build wealth over the long haul. If I don't think a company won't be around when I retire, I'll buy it through a broker, not a DRIP.

PROS

You are buying directly from the company- so you bypass the broker fees. Not all dividend reinvestment plans are free, but the one dollar or so fee per purchase is still cheaper than a broker (even Sharebuilder, which is $4). Fees eat up your returns. Think of it like your savings account. Would you rather pay ING, or whomever, no money or a buck or two every time you made a deposit, or ten dollars? Same deal. Fees for any investment, mutual funds, stocks, etc., should not exceed the 2% benchmark. Frankly, I think it should be closer to 1%, especially if you don't have a whole lot of money to begin with.

You can buy stock with only a little money at a time. Most plans have a minimum investment of $25 or $50, oftentimes you can buy online. Note that you are usually buying in whole dollar amounts, so it will be fractional shares.

Dividends are reinvested every quarter to help your money grow. The max 15% tax on dividend earnings is encouraging other companies to start paying them out. Costco just paid its first dividend a couple years ago.

You can invest automatically. Most plans let you invest at least once a month directly from your checking account. Dollar cost averaging will boost your returns, forcing you to buy even when the market is low, thereby decreasing the average cost you paid for the stock. Like all savings, dividend reinvestment plans can become a habit that you don't even feel pinching your pocket. Well, at least not too much.

CONS

Fees. There is often a start up fee. Because companies almost always require that you already own a share in order to participate, there is a fee for the use of services to put that stock in your name. The links to the stock I mentioned is for Moneypaper, the service I used to get that first share and then enroll me in the company's plan, but there are others out there. Some plans even have fees to purchase dividends! Again, the fees are not usually high, and certainly not as high as a broker. But dividend reinvestment plans speak to the little guy and gal, and our returns get squeezed by any fee, no matter how small. Fifty bucks a month on a plan with no fee is ideal. Fifty bucks a month on a two dollar plan is not so ideal. It means the stock has to increase 2% just to break even. Of course, you could counter it by increasing how much you invest by another fifty bucks, but an easy way to invest each month might then make you pause.

Buying that first share or meeting the minimum. For the most part, it is easy and relatively affordable to purchase that first share. However, some plans require several shares, or even $500 and up worth of stock. Just make sure you read the plan's minimum requirements.

Record-keeping. You need to declare things like taxable gains or losses based on your cost basis. In other words, keep every monthly, quarterly and year-end-statement, and look out for your 1099-DIV from the company at the end of each year. If you do your own taxes, you will need to figure out your own cost basis, which can be a headache. I hand mine off to an accountant, and if I sell a lot of stock, it's usually an extra ten bucks for him to figure it out.

RESEARCH. Dividend reinvestment plans are a great low-cost way to buy stock automatically. You have the freedom to start or stop an automatic purchase plan, and it's an accessible way to increase your net worth. You can search for participating companies through Moneypaper, Computershare (formerly Equiserve), AST, and Mellon, or here for the Cubes. And while Sharebuilder is not officially a DRIP, they are philosophically best friends. At $4 a trade, you purchase dollar amounts (ie fractional shares) and dividends can be reinvested for free. At $4 a trade, however, it would be best to aim for a $400 purchase. The obvious benefit is that they are an online broker and you can buy virtually any stock. Even Berkshire Hathaway, or at least fractions of it.

See, it's not so bad. And it's kind of fun to go shopping for stock. Check out the lists of available companies, whittle down the free and no cost plans, research a company's financials before you purchase, and buy and hold to your heart's content.