The DRIP Answer Report
Q I’m new to the DRIP world. What’s the difference between what
you call No-Load Stocks™ and dividend reinvestment plans?
A An easy way to answer your question is by saying that all No-Load
Stock™ plans are DRIPs, but not all DRIPs are no-load stocks.
More than 1,100 companies offer dividend reinvestment plans.
These plans allow investors to buy shares directly from companies.
Shares are purchased with dividends that the company reinvests for
participants. In addition, most DRIPs permit optional cash investments
that participants send directly to companies to purchase additional
shares. The one catch is that in most DRIPs, an investor already must
be a shareholder of record of the company in order to participate in
No-load stocks differ from other DRIPs in that no-load stock plans
permit investors to make their initial purchase of stock directly from
the company. No-load stock plans come in two varieties — plans that
are open to all investors and “limited” no-load stock plans that are available
only to certain investors, usually customers of the corporation or
residents in the state or states in which the company operates. Thus,
the main distinction between a simple DRIP and a no-load stock plan
is that the former requires you to already be a shareholder in order to
participate; the latter permits investors to make their initial purchase
directly from the company.
Another distinction is that certain ancillary services, such as IRA
options, automatic investment services, weekly and even daily stock
purchases, and telephone redemptions, are available much more frequently
in no-load stock plans than in basic dividend reinvestment
The number of no-load stock plans now stands at more than 600,
that’s up from 52 at the end of 1994.
* * * *
Q What is the difference between holding stocks in “street” name
versus having them registered in your name? Why does this matter
for DRIP investors?
A When an investor holds stock in “street” name, the shares are registered
in the name of the brokerage fi rm through which the stock
is bought. For example, let’s say you buy 200 shares of McDonald’s
through Charles Schwab. If the shares are held in “street” name, Mc-
Donald’s recognizes your shares as being held by Schwab. In some
cases, McDonald’s won’t even know that you are a shareholder of the
company. Rather, McDonald’s knows that Charles Schwab has a certain
amount of shares registered in Schwab’s name. If you own stock in
“street” name, all communication between you and the company is
routed through the broker — dividend payments, annual and quarterly
reports, proxy statements, etc. Conversely, if the stock is registered in
your own name, you are registered directly on the company’s shareholder
rolls. The company has your identity as a shareholder of record,
and all communication is between you and the company.
Understanding the distinction between “street” name ownership
and direct ownership is critical for DRIP investors. Since one reason
companies offer dividend reinvestment plans is to boost direct ownership
of stock, companies require their DRIP participants to register
shares in their own name, not “street” name. If you are interested in
a particular company’s DRIP, and the company requires you to own
stock before you can enroll in the plan, the shares you obtain in order
to be eligible to join the DRIP must be registered in your own name,
not “street” name. This is such a critical point that I’m going to repeat
it for new DRIP investors — In order to enroll in company-sponsored
DRIPs, you must have the shares registered in your name, not “street”
name. Be prepared for your broker to try and talk you out of owning
stock in your name, and most brokers now charge an additional
fee to register stock in the name of the investor. Still, if you want to
participate in a company-sponsored DRIP, you must have the stock
registered in your own name.
Why would investors want stock registered in “street” name? One
reason is convenience. If you own 10 different stocks and hold all of
them in “street” name, your broker will provide a single consolidated
statement showing ownership of all 10 stocks. Conversely, if you are
in 10 different dividend reinvestment plans, you will receive 10 different
* * * *
Q I hold several stocks in a Schwab account and reinvest the dividends.
Is there an advantage or disadvantage to using a brokerage
account instead of dealing directly with the stock issuer?
A The reinvestment plans offered by brokerage fi rms such as Schwab
are decent, to a point. They will reinvest dividends for you, oftentimes
without a fee. However, you need to be aware of a few things:
• If you are in the brokerage fi rm’s dividend reinvestment plan,
you are not in the company-sponsored plan. That is important to understand.
If the company-sponsored plan offers a discount on shares
purchased via reinvested dividends, you will not likely receive this
discount if your broker reinvests the dividends.
• Check to see if your broker buys both full and fractional shares
with your reinvested dividends. If your broker buys only full shares
of stock, your dividends could be in a money-market account until
you accumulate enough money to buy a full share. You want your
dividends to be in the market as soon as possible generating market
returns. Company-sponsored plans reinvest dividends to buy both full
and fractional shares.
• If you are in your broker’s reinvestment plan, you will not be
able to make optional cash investments for little or no money and in
amounts as small as $10 or $25. For example, Coca-Cola’s dividend
reinvestment plan permits optional cash investments of just $10.
Coca-Cola does not charge you a penny in commission to buy stock. If
you are reinvesting dividends in Coca-Cola via a broker plan, you will
not be able to buy Coca-Cola stock at $10 a pop and pay no commissions.
You will pay the broker’s full freight when you make additional
purchases through the broker’s plan.
Bottom line: If all you want to do is reinvest dividends and consolidate
your holdings under one roof, broker reinvestment plans are
acceptable. If you want the ability to buy additional shares with small
amounts of money and pay little or no fees, company-sponsored plans
are the better choice.
* * * *
Q I currently have a large investment with a brokerage fi rm, and
I am very dissatisfi ed. I want to change to DRIPs, but I don’t know
what to do. Can you help?
A In order to transfer your brokerage stock to DRIPs, you need to
understand the following:
• Not all companies offer DRIPs. Make sure your stocks have company-
sponsored DRIPs. You can check by calling the fi rm’s shareholder
• In order to enroll in company-sponsored DRIPs, you must have
the stock registered in your own name. If you have an account at a
brokerage fi rm, and the broker is holding the stock certifi cates, you
now have the shares registered in “street” name. In order to be eligible
to join DRIPs, you must tell your broker to re-register the shares in
your name. The broker will tell you that’s a bad idea — brokers like
to hold shares in street name since it gives them control of the asset
— but you need to have the stock registered in your name in order
to join DRIPs. Unfortunately, your broker will probably charge you a
fee to re-register the shares.
• Once the stock is registered in your name, you’ll receive the stock
certifi cates in your mailbox. Most DRIPs offer safekeeping services.
When you join the DRIP, you’ll probably be able to send the stock
certifi cates to the company if you don’t want to hold them.
* * * *
Q I’m a new subscriber to your newsletter. I see you use the term
“OCP” quite a bit. What does “OCP” mean?
A ”OCP” stands for “optional cash payments.” Most DRIPs, in addition
to reinvesting dividends to purchase stock, permit investors
to send lump sums of money directly to the company to purchase
shares. In many cases, the minimum OCP is just $10 or $25. Investors
with deeper pockets oftentimes may invest up to $100,000 per year.
These “optional cash payments” are exactly what the name implies
— “optional.” DRIP participants do not have to make OCPs, nor do
participants have to send in the same amount every month. Optional
cash payments, in my opinion, provide the real power of DRIP investing
since this feature allows investors to accumulate stock in quality
companies in amounts that fi t their respective pocketbooks. There is
no other investment vehicle, including mutual funds, that provides
investors with such flexibility.
* * * *
Q I am considering DRIPs as an investment, but I’m worried
about always having to add money. How often do I have to add
more shares to the plan? Can I add a few shares and stop for a few
months before adding more?
A I receive this question a lot, especially from newcomers to DRIPs.
One of the beauties of DRIPs is that the plans are incredibly flexible.
Most plans allow investors to purchase additional shares monthly or
weekly. However, these “optional cash investments” are just that —
optional. You are under no obligation to make monthly or weekly
purchases. To be sure, some DRIPs may require the ownership of, say,
fi ve or 10 shares to remain in the plan. However, you are under no
obligation to buy stock on a regular basis in these plans. Of course, the
power of dividend reinvestment plans is the ability to make regular
investments with relatively little money. Still, you are under no obligation
to do so. One exception is if you decide to sign up for automatic
investment services in a dividend reinvestment plan. Many DRIPs
allow investors to make regular investments via automatic debit of
a bank account. In these instances, investors are obligated to invest
on a monthly basis. However, if you join an automatic investment
service and decide, over time, you do not want to maintain regular
investments, you can bow out of the service providing you’ve met
the minimum investment required by the DRIP.
* * * *
Q If I invest $10 or $50 per month in a company’s dividend reinvestment
plan, what do I get for my money? Does the company hold my money until
I can buy a full share of stock?
A The beauty of dividend reinvestment plans is that your money
buys both full and fractional shares. If you invest $10 in a stock that
trades for $50 per share, the DRIP will buy you 0.20 share of stock.
Your money is invested in the stock, not held until you have enough
to buy a full share. Thus, all of your money is working for you right
away in dividend reinvestment plans.
* * * *
Q I am planning on buying some DRIPs. How many DRIPs do
you think is good to own?
A Let me commend you on getting started in DRIPs. The biggest factor
that will affect your long-term fi nancial well-being is how well you
harness the power of time in an investment program. You harness the
power of time by getting started investing as soon as possible.
When you start out investing, don’t worry so much about immediately
having a diversifi ed portfolio. Rather, just get started. The process
will take care of itself over time. You can start with three or four stocks.
Add to the number of stocks once you build up the number of shares
in each holding to, say, 25 or 50 shares. Ultimately, you’ll probably want
13-17 dividend reinvestment plans in order to achieve some diversifi-
cation. (You can reduce the number of individual stocks needed
for diversifi cation purposes if you combine stocks with a few mutual
funds.) If you buy a few quality companies and get the process started,
you’ll see how infectious it becomes and how easy it is to get to 13
to 17 stocks. In fact, a problem most DRIP investors run into at some
point is not having too few stocks in a portfolio, but too many.
* * * *
Q If you have the time to watch your stocks, why not own 40 or
50 stocks? I’ve been advised to have only 10 or 12.
A I believe a more focused approach has several advantages:
• Maintaining a manageable portfolio of stocks — say 15 to 25 —
makes it easier to maintain good record-keeping disciplines. Owning
50 stocks may complicate things come tax time if you’ve been buying
and selling shares in your DRIPs.
• Most investors don’t have 40 or 50 good investment ideas. If
you have 50 stocks, chances are you are watering down your best
investment ideas with a lot of mediocre ones. I prefer to maximize
the power of my best ideas.
• If you have 40 or 50 stocks, you may have trouble following all of
the stocks. If you aren’t able to follow your stocks closely, you’ll have
problems knowing when to sell. With fewer stocks, you can truly stay
on top of your holdings and monitor whether the reasons you bought
still hold. I know a lot of investors buy 40 or 50 stocks in the name of
portfolio diversification. The fact is that you can be reasonably diversified
owning 15 or 20 stocks, especially if you round out your portfolio
with mutual funds.
* * * *
Q I am 53 and will come into some inheritance in the near future.
I would like to be able to leave something substantial to my heirs
while at the same time be able to enjoy some proceeds when the
need is greatest in my later years (say 70). It has occurred to me that
taking $50,000 and putting it into a quality stock like AT&T, which
has a long history of paying dividends, could be wise. I would be
letting the effects of full dividend reinvestment compounding take
effect for 10-15 years. The hardest thing for a small investor like
me is to acquire enough shares of a quality issue to let them really
work for you. At 70, I could convert to partial dividend reinvestment
and enjoy some of the dividend income as well. The conventional
wisdom from friends is to go the route of diversifi cation. But in my
case, it doesn’t seem like diversifi cation is an important issue.
A I probably come down somewhere between you and your friends.
What I don’t know is how signifi cant $50,000 is to your overall fi nancial
picture. Obviously, if you have a portfolio of $1 million, putting
$50,000 into single stock, such as AT&T, would not be dangerous, in
my opinion. On the other hand, if $50,000 represents the bulk of your
investment funds, I would be reluctant to put it into a single stock,
even one I like as much as AT&T. Remember that AT&T is becoming a
dramatically different company than the one that paid high dividends
for many years. In fact, one could argue that, given its focus on cable
television and other telecommunications markets and the need for
capital, you may see AT&T go several years without raising its dividend.
Since dividends seem to be a priority for you, AT&T may not be the
best choice for a one-stock portfolio.
What I would do with the $50,000 is spread it over four or fi ve
stocks. You would still have a good chunk of money in each company,
yet you wouldn’t be placing all of your bets in one stock. If you like
AT&T (800-348-8288), you could keep this as one of your stocks. I
might add Regions Financial (800-922-3468), a quality regional bank;
a health-care stock, such as Johnson & Johnson (800-328-9033),
Merck (800-774-4117), or Pfi zer (800-733-9393); and a technology
company, such as Lucent Technologies (800-774-4117), Hewlett-
Packard (800-286-5977), or Intel (800-298-0146). All of these stocks
have DRIPs — Regions, Merck, Pfi zer, and Lucent allow you to make
even your initial purchases directly — so you could add to your investments.
The last issue to consider is whether to invest the inheritance
all at once or space out your investments over time. Obviously, if you
put all of the inheritance into the market at once, you run the risk of
investing at or near the top. Interestingly, however, academic studies
show that lump-sum investing is usually better than spreading out
investments over a period of time. That’s because the market generally
trends higher over time. A lump-sum investment maximizes the
power of time. Still, for most people, spreading the money out over a
period of time may be a more comfortable approach. I would probably
invest one-third to one-half of the money immediately in the market
and invest the rest within 12-18 months.
* * * *
Q I’m a novice investor with about $1,000 to invest. Am I better
off opening an account with a brokerage fi rm or should I invest
A I think you are probably better off buying a few DRIPs directly.
You could follow the portfolio suggestions I laid out in the previous
response to the individual who had $50,000. A few additional suggestions
for a portfolio are Walgreen (800-286-9178), the drugstore chain,
and Equifax (888-887-2971). Both allow initial investments directly.
One reason I prefer DRIPs to a brokerage account for newcomers
is that money at a broker, especially an online broker, may tempt you
to trade too often. And if you trade even just once a week, you’ll see
your $1,000 erode quickly. It is not easy to trade stocks with DRIPs.
Thus, your money will stay put and grow for you.
* * * *
Q It seems to me that if I can only send $50 to buy shares in a
stock with a $100 price tag, it will take a very long time for my
money to grow. Wouldn’t I be better off putting my $50 in a $10
A Buy quality, not price. The beauty of dividend reinvestment plans
is that the programs make buying high-quality stocks affordable. If
you avoid buying quality stocks simply because the per-share price
tag is high, you are not taking advantage of one of the major benefi ts
of investing via dividend reinvestment plans. Don’t buy a $10 stock
simply because you can buy more shares with your $50 investment.
Buy the best stocks you can fi nd. After all, a 20% return on your money
in a $100 stock is the same as a 20% return on your money in a $10
stock. Don’t make the false assumption that lower-priced stocks have
the ability to post more dramatic price increases than higher-priced
* * * *
Q I keep seeing all of these initial public offerings taking off in
price when they go public. Should I try to get in on the action?
A An initial public offering (IPO) occurs when a private company
sells stock to the public for the fi rst time (“going public”). When a
fi rm decides to go public, it usually hires an investment bank to handle
the offering. The investment bank lines up a lot of brokerage fi rms and
investment banks to help peddle shares to the public.
Many IPOs have taken off following the offering. Most notable
was Theglobe.com, an Internet company. The stock rose 606% on
its fi rst day of trading. Obviously, if you could have bought the stock
at its IPO price, you would have made a lot of money.
Therein lies the problem with IPOs. You can’t buy the stock at
the offering price. Why? Because the best IPOs are available only to
the biggest and best clients of the investment banks and brokerage
fi rms taking the fi rm public.
Oh sure, you can buy the stock after it begins trading. But if you
have to wait until after the stock goes public, you’re buying at higher
prices, sometimes much higher prices.
That’s what has happened to many investors who placed “market
orders” to buy hot IPOs. Market orders don’t specify the price at which
you want to buy the shares. Rather, market orders are fi lled at the
prevailing market price when the order hits the market. The problem
with using market orders to buy IPOs is that the market moves quickly,
leaving yourself vulnerable to buying the stock at much higher prices
than you intended. Stories abound of investors who placed market
orders for stocks going public at $10 or $15 only to fi nd that their
market orders were fi lled 30 or 40 points higher. Moral of the story:
Don’t use market orders to buy IPOs.
In fact, you’d probably be better off avoiding IPOs until they have
traded at least for a few months. Indeed, many of the “hot” IPOs that
gained 200% or 300% on the initial trading day are now trading near
or even below their initial offering prices.
As far as accessibility to the best initial public offerings, the
situation is improving a bit for individual investors. Several discount
brokers have reached alliances with top investment bankers to obtain
pieces of offerings for customers. Rest assured, however, that unless
you do a lot of business and have a lot of money on account at these
discount brokers, your chances of getting in on the action are still
And if a broker calls to say that he has a “hot” IPO, be very skeptical
of the quality of the investment. If small investors can get a piece
of an IPO, it usually means that the offering is damaged goods that
big, institutional investors don’t want.
One last point. Rarely does an IPO offer a dividend reinvestment
plan. In fact, most IPO stocks don’t pay dividends. If you like investing
via DRIPs, IPOs are not for you.
* * * *
Q How much should I invest each time to justify some of the fees
being charged in DRIPs/Direct Purchase Plans?
A I think there are several ways to manage fees in DRIPs. The fi rst
way is to understand that many DRIPs have a two-tiered fee schedule.
For investments made with a check, the plan may charge one fee; for
investments made via automatic monthly debit, the plan may charge
a different fee, which is usually lower. If you are willing to commit to
monthly investments, you should receive a break on fees.
Since many DRIP fees are based on a per-transaction charge and
not infl uenced by the investment amount, the fees are less punitive the
more money you invest. For example, if you invest just $50 and incur
a $5 fee, the 10% charge creates a high hurdle for your investment to
overcome. Conversely, if you invest $500 and incur a $5 fee, the 1%
charge is much more palatable. You probably shouldn’t pay fees that
amount to more than 2% or so of your investment. That may mean that
instead of investing monthly in plans with fees, you may be better off
bundling your money and investing three or four times per year.
* * * *
Q DRIPs seem to make so much sense, I wonder why all companies
don’t offer them. It seems like a win-win for companies and
A One reason companies choose not to offer DRIPs is the cost of
administering the plans. Recently, I talked with an executive at a
Fortune 500 company with hundreds of thousands of shareholders. The
individual told me that it costs the company $4 million (or $12 per
individual) to service registered shareholders. This particular company
charges a relatively small fee in its DRIP to defray some of the costs.
Even with the fee, however, the costs are sizable. Some companies,
especially those that don’t have a strong consumer presence and
therefore cannot benefi t from shareholders buying the company’s
goods and services, may feel the costs to administer a plan are not
worth the benefits.
* * * *
Q If I hold dividend reinvestment plans in an Individual Retirement
Account, do I have to reinvest dividends?
A You cannot take distributions from an IRA without incurring at
least taxes on the distributions and penalties if you are younger than
age 59½. Thus, if you take receipt of dividends from DRIP IRAs, that
would be considered a distribution for tax purposes. Now, let’s say you
have DRIPs in an IRA that is being administered by a trust company.
If the trust company offers a money market account within an IRA,
it might be able to place the dividends within the money market account
instead of reinvesting them in the stock. Keep in mind that the
dividends are still held in an IRA (the IRA money market account), so
you still won’t be able to receive them without incurring taxes and
possibly a penalty. Bottom line: Make sure you reinvest dividends on
DRIPs held in IRAs.
* * * *
Q One of the problems I see with investing in dividend reinvestment
plans is that you don’t have precise control over the buy and
sell price. To me, this is a big deal. What do you think?
A I would agree that you don’t have the control over the buy and
sell price through dividend reinvestment plans that you have investing
with a broker. Fortunately, the situation is improving in the DRIP
world. Many dividend reinvestment plans now purchase shares weekly
or even daily, when practical. This is a far cry from the quarterly or
monthly buying patterns of most DRIPs fi ve or 10 years ago. Also, a
number of dividend reinvestment plans now permit DRIP investors
to sell their shares on a daily basis via the telephone. This has greatly
improved the transaction speed on the sell side.
Quite frankly, the fact that I don’t have precise control over the
buy and sell price doesn’t bother me. I fi gure that, over time, I’m just
as apt to buy shares at a more favorable price than I am to pay a higher
price. And since I sell so infrequently, the fact that I cannot sell shares
now doesn’t concern me. In fact, I think one of the things that gets
investors into trouble is that it is too easy to buy and sell stocks these
days, especially with the advent of online trading. I think too many
investors trade stocks simply because they can, rather than because
they should. I also think that having precise control over the buy and
sell price may cause you to try to “micro” time purchases and sells. I
can’t tell you how many times I’ve seen investors fail to buy a stock
simply because the stock never fell to that investor’s “buy” price. If you
try to fi nesse the purchase price too much, oftentimes you’ll never
buy the stock because it rallies away from your target price. Don’t
worry so much that you cannot buy stock in dividend reinvestment
plans at a precise price. If it’s a good stock and you’re investing for
the long term, it shouldn’t matter.
* * * *
Q I just bought shares in a particular dividend reinvestment plan.
In the one-page description of the plan, it says that I will not be allowed
to send money for additional optional cash purchases until
AFTER I have reinvested some dividends, which will not be until
September. It seems frustrating fi nally to start a DRIP for my child
and then have to sit on my money for about three months.
A Unfortunately, what you have encountered is not uncommon
in the DRIP world. And, yes, it is frustrating to wait several months
before you can add to positions via optional cash payments. How do
you avoid such surprises? I’ve said this before, but it bears repeating
— read the plan prospectus before you buy a DRIP.
While we’re on the subject of DRIPs and reinvested dividends,
another development that is becoming more popular is an eligibility
requirement to reinvest dividends. For example, a particular plan may
allow you to enroll with one share but may not allow you to reinvest
dividends until you have accumulated 10 or 50 shares. This information
is in the prospectus.
* * * *
Q I just received word that my online broker is going to begin
charging $20 to ship certifi cates. What gives?
A Your question highlights one of the “hidden” fees of the online
world. Yes, many online brokers tout their very low fees. What they
don’t tout, however, is that for DRIP investors who want to use the
online broker to obtain the fi rst share needed to enroll in many DRIPs,
the costs may be signifi cantly higher than the low commission. It’s
not unusual for brokers to charge $20 or more to register shares in
the name of the investor. Since you must have the stock registered in
your own name to join company-sponsored DRIPs, this fee adds to
the cost of getting into the plans.
* * * *
Q You always talk about buying DRIPs, but never when to sell.
What are some factors to consider when deciding whether to sell a
A DRIP investing is long-term investing, in my opinion. Thus, I am
a bit reluctant to sell stock when the price rises or drops sharply in
a short period of time. Of course, there may be very good reasons to
sell a stock. One reason is what I call the “stupid acquisition.” It’s not
a stretch to say that most companies overpay for acquisitions. Why?
Unfortunately, CEOs’ egos often get in the way of what is best for the
shareholders. Empire building supplants shareholders’ interests, and
the result is that the acquirer generally pays more than the acquiree
is worth. This is especially true when two or more companies are
competing for the same company.
Another reason to sell a stock is because the company’s financial
position has become loaded down with debt. This often happens when
companies finance the “stupid acquisition.” If you’re investing for the
long term, you want a company that’s going to stay in business. High
debt levels are dangerous. If a company’s long-term debt as a percentage
of capital is well over 50%, you should become concerned.
What about selling companies when their products become obsolete?
Obviously, a company whose competitors have passed it by,
technologically speaking, is a worthwhile sell candidate. The problem
is that most investors — yours truly included — aren’t smart enough
to keep up with the rapidly changing technologies in such fi elds as
computers, electronics, and software. Therefore, we probably shouldn’t
be investing in these companies in the first place.
* * * *
Q What is the best way to sell stocks from a dividend reinvestment
A This is a timely question since I recently sold one of my dividend
reinvestment plans. Most DRIPs allow investors to sell stock directly
from the plans. Companies may require DRIP participants to notify
the plan in writing with their sell instructions. However, a number of
companies, such as Browning-Ferris, allow DRIP participants to sell
their shares via the telephone.
Here are the steps I followed:
• Before I sold my DRIP shares, I first had to clear up a potential
problem. When I purchased the initial shares I needed to join the DRIP,
the broker sent me the stock certifi cate representing those initial
shares. Once I joined the DRIP, I was reinvesting the dividends on all
my shares, both the shares I held in the plan as well as shares I held
in certifi cate form. If I called to sell my DRIP shares, however, the fi rm
would have sold the shares held in the plan but wouldn’t have sold
the shares I held in certifi cate form. Thus, I would have been stuck
trying to sell the fi ve shares I held, which would have been more
costly and less convenient. Thus, before I sold my shares, I sent my
stock certifi cate representing fi ve shares to the company to hold for
me in book-entry form in the DRIP. After obtaining the mailing address
from the transfer agent, I sent the certifi cate via registered mail.
• Once all of my shares were held by the company, I called the
toll-free number provided by the company’s transfer agent. I gave the
instructions to sell all of my DRIP shares.
• It will take a few weeks to receive the sale proceeds.
As you can see, selling through the company may take some
time. If you are concerned about speed on the sell side, make sure
your DRIP is holding all of your shares. Also, an alternative to selling
through the plan is to sell your DRIP shares through a broker. To sell
through a broker, you’ll need to have the transfer agent send you a
certifi cate representing all of the shares you own in the DRIP. Once
you have the stock certifi cate, you may go to a broker and sell the
shares immediately. Keep in mind it may cost you more to sell through
a broker than through the dividend reinvestment program.
* * * *
Q What effect on computing the cost basis does transferring
some shares of a stock have on a dividend reinvestment program
in which I participate?
A If you transfer shares from a brokerage account to a DRIP account
by reregistering shares in your own name, there is no taxable
event, and your cost basis does not change. For example, let’s say you
own Coca-Cola stock that is registered in “street” name and held by
the broker. You want to join Coca-Cola’s dividend reinvestment plan,
so you reregister the shares in your own name. The shares are then
transferred to you so you can enroll in the dividend reinvestment plan.
If your cost basis on your Coca-Cola shares with the broker was $50
per share, the cost basis will remain $50 per share in the dividend
Now, a popular strategy for obtaining the fi rst share to join many
DRIPs is transferring one share from one investor to another. When
I transfer shares from my account to another person who wants to
join that DRIP, I record the transfer as a sale of stock. In this instance,
I use my cost basis on that share to determine my capital gain or loss
for tax purposes. When you transfer shares in this way, you’ll receive
a statement from the dividend reinvestment plan showing the date
of the transfer and the price of stock. The person who is receiving
the transferred share or shares should use that date and price as his
or her cost basis.
Now a sharp reader is probably saying that you cannot sell one
share of stock in your DRIP using the “specific-share method” and sell
the rest of the shares in the DRIP using the “average-cost” method.
That’s right. Technically, if you sell only part of your shares in a DRIP,
you need to choose either the “first-in, first-out” method or the specific-share
method. And when you sell the remaining shares, you must use
that same method, too. From a practical standpoint, however, I know
that if I sell just one share of stock via a transfer, and later sell the rest
of my shares at one time, I’m probably going to use an average-price
method because of its ease of use. I’m not advocating that you follow
my example, of course. But I don’t believe that the one-share transfer
should drive the cost-basis computation.
* * * *
Q Should I include reinvested dividends in my cost basis when
selling my DRIP shares?
A Yes. When you sell shares of stock, you must compute a cost
basis for tax purposes. When you fi gure your cost basis, remember
to include reinvested dividends. If you don’t include reinvested dividends,
your cost basis will be artifi cially lower, which means your tax
hit will be greater. The way I compute the cost basis for my holdings
is the following (this assumes that when I sell shares from a DRIP, I
sell all of the shares):
1) Find the amount of my initial investment.
2) Total the amount of optional cash payments.
3) Total the amount of dividends that were reinvested.
4) Add these three items together, and this is my cost basis.
5) Subtract this cost basis from the proceeds of the stock sale, and
this is my capital gain/loss for tax purposes.
This method has appeal for several reasons. First, you deal with dollar
amounts using this method, not share amounts. Thus, this method
doesn’t require you to adjust your stock purchase prices for splits.
Second, this method doesn’t require you to deal with fractional shares.
Rather, you are simply adding the total dollars you invested. If you
keep the statements that the companies send you on a regular basis,
you should have no trouble computing your cost basis.
* * * *
Q What are some of the tax implications of investing in DRIPs?
A Concerning DRIPs and taxes, there are a few key things to remember:
■ Even though dividends are being reinvested, they count as
ordinary income for tax purposes. Therefore, remember to include
reinvested dividends as part of your income. Companies will send
you 1099 forms at the end of the year showing how much was paid
■ It is important to keep track of the stock price each time you
make purchases in a DRIP. This cost basis will come into play when
you sell stock and have to determine your cost basis for tax purposes.
If you can identify the shares of stock sold, your cost basis is the cost
of those particular shares of stocks. However, if you sell securities at
various times and cannot identify the shares that are sold, the cost
basis of the securities sold is the cost of the securities acquired first
— the “first-in, first out” method.
■ You must report as income any service charges paid on your
behalf by the company, although you can deduct these charges in the
year they are paid as a miscellaneous deduction if you itemize.
■ If you purchase shares at a discount, you must report as income
the difference between the cash you invest and the fair market value
(full value) of the stock you buy.
* * * *
Q I have recently bought several DRIPs. However, one thing puzzles
me. If you’re taxed on dividends from these plans even though the
dividends are reinvested, should you then have to pay capital-gains
tax on shares purchased with these dividends?
A Dividends are considered ordinary income for tax purposes, just
like wages and other sources of income. Think of it in these terms — If
you used your wages to buy stock, you would have to pay capital-gains
tax on shares purchased even though you paid taxes on your wages.
So, too, will you have to pay capital-gains taxes on shares purchased
with dividend income that is reinvested. However, remember that, in
order to determine whether you must pay capital-gains tax, you must
fi rst determine whether you have a capital gain. In order to do this,
you need to know the cost basis for your shares. If you sell all of the
shares of a particular dividend reinvestment plan, your cost basis is the
amount of your initial investment, the sum of all reinvested dividends,
plus the sum of all optional cash payments. Once you have this total,
subtract it from the proceeds of the sale to determine if you have a
gain or a loss. Oftentimes, investors forget to include reinvested dividends
in their cost basis.
* * * *
Q What dividend reinvestment plans are tax deferred, if any?
A Unfortunately, even though dividend reinvestment plans allow you
to dodge the broker, you cannot dodge Uncle Sam. Dividends that you
reinvest in these plans are still considered ordinary income for tax
purposes. And you have to pay taxes on any realized gains in your DRIP
investments. Of course, if you hold DRIPs in an Individual Retirement
Account, you don’t incur any taxes until you withdraw funds from the
IRA. So in that sense, DRIPs may be tax deferred, but only if they are
held in a tax-sheltered account such as an IRA. A growing number of
DRIPs have IRA options built into their plans, thus making it easier to
invest tax deferred in select dividend reinvestment plans. The following
DRIPs — all of which allow investors to make even their initial
purchase of stock directly — offer IRAs in their plans:
* Allstate ........................................................ (800-448-7007)
Amer. Electric Power ................................ (800-955-4740)
Ameritech ................................................... (800-774-4117)
* Atmos Energy ............................................. (800-774-4117)
Bell Atlantic ................................................ (800-631-2355)
* Campbell Soup ........................................... (800-649-2160)
* Exxon .......................................................... (800-252-1800)
* Fannie Mae ................................................. (888-289-3266)
* Ford Motor ................................................. (800-955-4791)
McDonald’s ................................................. (800-774-4117)
* MCN Energy ............................................... (800-955-4793)
OGE Energy ................................................ (800-774-4117)
* Philadelphia Suburban ............................. (800-774-4117)
SBC Communications ............................... (888-836-5062)
Sears, Roebuck & Co. ................................ (888-732-7788)
Wal-Mart Stores .......................................... (800-438-6278)
* Companies that offer the Roth and Education IRAs in
addition to the traditional IRA.
* * * *
Q What happens to my DRIPs when I die?
A As is the case with any securities or other assets, presumably
you distribute the DRIPs via your will. Heirs to the DRIPs need to go
through the transfer agent of the DRIP companies in order to change
the registration. One benefi t for individuals who inherit stocks, including
DRIPs, is that the cost basis for the securities is “stepped up” to the
price at the time the stock is inherited. Thus, let’s say your grandfather
was fortunate enough to buy McDonald’s in the ’60s and accrued huge
capital gains during that time. If he leaves McDonald’s stock to you,
your new cost basis which comes into play for tax purposes when
shares are sold, is the price on the date of his death.
* * * *
Q I am accumulating a lot of paperwork with my DRIPs. Is it better
to register my stocks with a broker for record-keeping purposes?
If so, should I keep all of my statements from past transactions?
A If you register your stocks with a broker, you will not be able to
participate in a company-sponsored dividend reinvestment plan. In
order to invest in company-sponsored DRIPs, you need to have the
shares registered in your own name. If you want a consolidated statement
from a broker, the shares must be registered in “street” name,
thus eliminating you from being able to participate in the company sponsored
DRIP. If you like investing in DRIPs, don’t register the
shares with a broker. However, if you are fi nding the record keeping
a bit onerous and you are not maximizing the opportunities in the
DRIP (such as the ability to make optional cash investments), you
could move the shares to a broker to ease record keeping. But you
will still need to keep the paper work for the shares you have already
purchased via the DRIP. You’ll need this information when you sell
those shares and have to fi gure out your cost basis.
If you are fi nding the record keeping of DRIPs to be a bit onerous,
plenty of software packages exist to help you handle your DRIP
records. Many DRIP Investor subscribers use the popular Quicken
software package. On the Internet, check out www.gainskeeper.
com for free portfolio-tracking services.
* * * *
Q I’m interested in getting my grandson started in DRIPs. How
can I go about giving him DRIPs as a holiday gift?
A It’s becoming more common for parents and grandparents to
forgo the music CDs and video games to purchase gifts of stock for
their children and grandchildren.
It’s very easy to give the gift of DRIPs. One way is by transferring
some shares you may have in a DRIP to another party. This is the easiest
and quickest way to enroll someone in a DRIP.
The process of transferring shares is relatively simple, although it
may differ slightly depending on the company and its transfer agent.
Generally speaking, individuals who want to transfer shares need
to obtain a “stock power” form from a brokerage fi rm or bank that
conducts transfers. Fill out the “stock power” form and include the
name, address, and social security number of the individual to whom
you are transferring the shares. You must have a “medallion” signature
guarantee on the stock power. This guarantee is usually available at
a bank or brokerage fi rm. When you have completed the form and
obtained a “medallion” signature guarantee, return the form to the
company or its transfer agent. You might want to include a letter
stating your intentions and specifying that you would like to enroll
the individual directly into the DRIP. Most companies will oblige. If
the transfer agent does not enroll the party directly into the plan, the
individual will receive a stock certifi cate and, in most cases, a DRIP
enrollment form. The individual who is receiving the transferred shares
will need to fi ll out the enrollment form and return it to the company.
Once the company receives the enrollment form, the individual can
usually start investing directly in the DRIP.
If you do not own stock in a company in which you want to give
shares as a gift, check to see if the fi rm has a “gift-giving” feature in its
DRIP. A number of no-load stock plans offer this feature. I have opened
“gift” accounts for my parents and found the process very easy.
If you set up an account for a child, consider setting up a Uniform
Transfer to Minors Account (UTMA). Funds in the account are in the
minor’s name and social security number and are considered to be
owned by the minor. Dividends paid on the account are taxable, most
likely at a preferred tax rate. The adult custodian is responsible for the
account until the minor reaches the age of majority. Any withdrawals
from the account are payable to the custodian on the minor’s behalf
until that time. If you are interested in creating a UTMA, contact the
company’s shareholder services department for the proper forms.
Wall Street Journal Readers
A Different Way To Play Financials
Charles Carlson, CFA
Editor, DRIP Investor Newsletter
I’m kind of partial to financial stocks for the remainder of the year. I think a slight uptick in interest rates will be a plus for. . .