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Drips, or dividend reinvestment programs, are poor investments for new investors since they lack diversification. They are also a tax nightmare.
Drips are usually promoted to people who are unsophisticated investors. They are not an appropriate first investment because you don't get diversification.
New investors should NOT start out buying individual stocks. They should start out buying very low cost (no load) index mutual funds from places like Fidelity, Vanguard, T. Rowe Price and a few others. Some suggested conservative Vanguard Index Fund portfolios are given in the article here .
I used a company dividend reinvestment program for IBM in the 1980's and 1990's. Doing my taxes was horrible when I finally sold some IBM to take profits. If I had to pay someone to do my taxes to account for all the years of accumulating a small number of shares each year, the cost of accounting for my reinvested dividends may have exceeded what I made! As it was, it took hours to figure out my gains on each little investment.
You can avoid the tax nightmare if you do dividend reinvestments in your IRA. Of course, this doesn't solve the problem of diversification, of lack of diversification.
If you want to reinvest dividends in a "stock like security" inside your IRA, then consider VTI. VTI is a "Viper" from Vanguard that you buy and sell like a stock. It represents the Wilshire 5000 which is the "total stock market." Here is a summary of VTI from Yahoo!
- The investment seeks to track the performance of a benchmark index that measures the investment return of the overall stock market. The fund employs a passive management strategy designed to track the performance of the MSCI US Broad Market index, which consists of all the U.S. common stocks traded regularly on the NYSE, AMEX, or OTC markets. It typically invests substantially all of assets in the 1,300 largest stocks in its target index, thus covering nearly 95% of the Index's total market capitalization.
- Total Expense Ratio = 0.07%
Most major brokerage houses will let you buy VTI with a single commission then they will let you reinvest the dividends with no extra fee. This works great if you have a small amount to invest one time and don't qualify to buy the minimum investment at the mutual fund companies directly. If you want to make regular investments, then you can save the commission costs and buy the Wilshire 5000 index mutual fund directly from the fund family.
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I welcome suggestions for future articles at Kirk's Market Thoughts.
DISCLAIMER: I own Vanguard's Total Stock Market Index fund and recommend it in my newsletter.
Kirk Lindstrom: Answers & my words are general in nature, are not meant as specific investment advice, and do not necessarily represent the opinion of anyone but Kirk. Individuals should consult with their own advisors for specific investment advice.
The copyright of the article DRIPS are not good investments in Investment is owned by Kirk Lindstrom. Permission to republish DRIPS are not good investments in print or online must be granted by the author in writing.
Comments
Feb 5, 2007 8:32 AM
Estela Kennen :
Kirk,
Point taken. I added a sentence in the article about
diversification, and I agree that managed funds or index funds are a simple
way for people to start investing. However, that doesn't change the fact
that some people want to own into a particular company, and a DRIP might be
a good way to do it. Also for people who have already have other
investments and want to get some experience in doing things themselves, but
without the overhead of buying regular stocks, or for kids who want to own
a piece of Disney, then DRIPS are not a bad way to go. No one investment
strategy fits all.
Apr 1, 2007 5:20 AM
James English :
Kirk is correct, but another reason for Buying DRIPS?
To have some
fun & creating Interest investing for Younger Generations..
Another is? To buy some High risk Stock and hope it goes up 30% a Yr...
such as NVO ( Novodisk ) over 400% past 10 yrs
To satisfy ones
Greed...( The Gambling Side of us ) vs having to dump $3,000 to get into a
Emerging Market Fund, just buy 1-2 of the stocks that Fund Owns
But, I would buy drips with just $10/mo, but at 1 Share at a time...or What
$100 would buy at a time..
For Seniors Buying 1 stock of a Co.
x 10 Differenet Companies and leave them to your Heirs.. For both Fun and
something they can participate into and you just might create their
intetest into investing into stocks as well.
have some fun with
investing...
Apr 1, 2007 9:56 AM
Im Smile :
Drips can be a pain if you do not keep good records.
The advent
of the pc spreadsheet solved a lot of the issue. Couple this with a little
tax knowledge and you should be fine. If your spreadsheet skills are
lacking there are plenty of software solutions and online trackers.
E*Trade online actually tracks by tier cost basis all of your drip
purchases automatically. Just buy 1 share of a drip stock and sign up for
dividend reinvestment, and the rest is done for you. Splits and other
impacts are automatically done for you. When you sell you can specify which
cost tiers you want to sell. It automatically tracks your basis,
gains/losses etc. You can export the data to excel. I've got a GTC sell
order on a drip right now involving 30 different cost tier lots. Sounds
like a nightmare but E*Trade has put together a very nice drip tracker for
their customers. There may be other brokers doing this as well, but I am
only familiar with E*Trade drip tracker.
Of course, I like to
double check their work so I keep my own spreadsheet to shadow what they
are doing. :)
_______
Also keep the following in
mind:
http://finance.yahoo.com/education/drip/dspp_plans/article/101139/Tax_Con
siderations_of_DRIP_Investing
"A few other strategies to
keep in mind in keeping the IRS at bay include the following:
If you never sold your DRIP stocks, the DRIP shares would be left to
your heirs as part of your estate. The market value for all the shares
will be stepped up to their value on the date of your death (or as of the
date six months following your death). This surely eliminates the need to
establish the historical cost basis of DRIP shares!
If sale of
the DRIP shares is absolutely required, the investor should consider
selling all the shares in a particular DRIP at once. This will create just
two entries on the investor's tax return, one for short-term capital gains
from the last few quarterly reinvested dividends, and one for long-term
capital gains (the sum of all the gains in the DRIP less the recent
reinvestments).
Above all, the importance of recordkeeping
cannot be overstated. Unlike other tax-related documents, DRIP statements,
recording all reinvestments and OCPs, should be kept indefinitely."
3 Comments
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