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The October 2020 issue of
DRIP Investor newsletter.

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 the plan.

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 plans.

The number of no-load stock plans now stands at more than 650, that's up from 52 at the end of 1994.

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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 firm 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, McDonald’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

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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 firms 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 firm’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.

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Q I currently have a large investment with a brokerage firm, and I am very dissatisfied. 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 firm’s shareholder services department.

• 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 firm, and the broker is holding the stock certificates, 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 certificates in your mailbox. Most DRIPs offer safekeeping services. When you join the DRIP, you’ll probably be able to send the stock certificates to the company if you don’t want to hold them.

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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 fit their respective pocketbooks. There is no other investment vehicle, including mutual funds, that provides investors with such flexibility.

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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, five 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.

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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.

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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 financial 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 diversification 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.

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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.

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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 diversification. But in my case, it doesn’t seem like diversification is an important issue.

A I probably come down somewhere between you and your friends. What I don’t know is how significant $50,000 is to your overall financial 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 five 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.

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.

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Q I’m a novice investor with about $1,000 to invest. Am I better off opening an account with a brokerage firm or should I invest in DRIPs?

A I think you are probably better off buying a few DRIPs 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.

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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 stock?

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 benefits 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 stocks.

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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 first time (“going public”). When a firm decides to go public, it usually hires an investment bank to handle the offering. The investment bank lines up a lot of brokerage firms and investment banks to help peddle shares to the public.

Many IPOs have taken off following the offering. Most notable was, an Internet company. The stock rose 606% on its first 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
firms taking the firm 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 pretty slim.

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.

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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 first 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 influenced 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.

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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 their shareholders.

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.

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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.

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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 five 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.

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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 finally 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.

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Q I just received word that my online broker is going to begin charging $20 to ship certificates. 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.

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Q You always talk about buying DRIPs, but never when to sell. What are some factors to consider when deciding whether to sell a stock?

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 fields as computers, electronics, and software. Therefore, we probably shouldn’t be investing in these companies in the first place.

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Q What is the best way to sell stocks from a dividend reinvestment plan?

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 certificate 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 certificate 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 certificate 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 certificate representing five 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 certificate representing all of the shares you own in the DRIP. Once you have the stock certificate, 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.

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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 reinvestment plan.

Now, a popular strategy for obtaining the first 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.

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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 figure 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.

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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 in dividends.

■ 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.

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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 first 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.

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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.

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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 finding 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 figure out your cost basis.

If you are finding 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.

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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 firm 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 firm. 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 certificate and, in most cases, a DRIP enrollment form. The individual who is receiving the transferred shares will need to fill 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 firm 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.

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