Photo: Freeimages.com/Johanna Ljungblom

One of the things I like about investing in dividend growth stocks is that – while there’s no guarantee – it’s a fairly easy way to generate a progressively increasing income stream over time. An important part of super-charging the wealth building effects of dividend growth investing is to reinvest your dividends, rather than taking the dividends as cash.

In general, there are two ways to reinvest dividends: through a company-sponsored Dividend Reinvestment Plan (DRIP) or directly through a broker. There are advantages and disadvantages with each:

 

Fees Are Generally Higher on DRIPs: Depending on your discount brokerage, you’ll usually pay a flat fee on share transactions. I use TD Ameritrade, and I pay $9.99 per share purchase regardless of the number of shares. In contrast, a lot of DRIPs have fees when buying shares (usually a percentage of the amount invested), and nearly all have a fee when selling shares. This makes sense, as the reason a company sets up a DRIP is to build a base of long-term investors. As an example, let’s use a widely held stock like Procter & Gamble (PG) to compare costs:

Cost to buy 100 PG shares through the DRIP: $4.50 ($2.50 plus 2 cents per share)

Cost to buy 100 PG shares through TD Ameritrade: $9.99

Cost to sell 100 PG shares through the DRIP: $27 ($15 plus 12 cents per share)

Cost to sell 100 PG shares through TD Ameritrade: $9.99

Total round-trip cost for the DRIP: $31.50

Total round-trip cost for TD Ameritrade: $19.98

PG does not charge a fee to reinvest dividends; some other companies do. TD Ameritrade, like many brokers, does not charge any fees when reinvesting dividends. You’ll have to examine your brokerage’s fees and the specific companies’ DRIP fees to determine which is best for you.

Advantage: Brokers

 

Sometimes Companies Offer Discounts on Share Purchases Through a DRIP: OK, the use of the plural word “companies” is a stretch here. I’ve only found one company that offers a discount on shares purchased with reinvested dividends through its DRIP: Aqua America (WTR) offers a 5% discount when you buy shares with reinvested dividends. Even though the discount is taxable, it still offsets the additional cost of buying and selling shares within their DRIP. If I decide to invest in Aqua America, I’ll do it through the DRIP.

Advantage: DRIPs (but only for certain stocks)

 

Using DRIPs Encourages a Passive Approach to Investing: There’s been extensive research that investors that try to time the market, attempting to get out when the market starts to move lower and get back in when the market begins to move higher, usually underperform passive investors. (This article shares some thoughts on a study by Fidelity Investments that showed that their best investors had forgotten about their portfolios – or died.) In my mind, DRIPs encourage investors to take a buy-and-hold mentality and avoid frequent trading that lowers long-term results in two ways. First, you have your investment plan when you invest in a DRIP: buy dividend-paying stocks and reinvest (or collect) the dividends. Knowing the plan makes it easier to stick to the plan. Second, while I can access my DRIP account over the Internet, I tend to look at my brokerage account more often. Because I’m not constantly looking at my DRIP account, I tend to treat it as “out of sight, out of mind” – right up until I need the money I’ve invested (and sell some stock) or a company stops growing dividends (and I sell my investment in that company).

Advantage: DRIPs

 

Trading Options is not Available in a DRIP: One strategy that I occasionally use to enhance my returns on dividend growth stocks is to sell covered calls against existing holdings. I’ve also purchased stock by selling cash-secured puts and collecting the premium to decrease my cost. Neither of these strategies (or any other options strategies) is available in a DRIP. This is the flip side of my previous point. DRIPs encourage long-term investing, while options (which have expiration dates, between a week and several months away) are part of a short to mid-term strategy. If that’s something that interests you, then there’s a place for both pieces. But you’ll need a brokerage account to use options.

Advantage: Brokers

 

Bookkeeping is Easier With a Single Broker: One of the major advantages of using a broker is that you can consolidate your investments into a single account. While this may seem like a small thing, if you have a lot of different investments – I’m thinking 15 or more – it can take a decent amount of personal organization to keep track of all of them. And this can be particularly important around tax time. You’ll receive a separate tax form for each DRIP, while a given broker will send you a single 1099-DIV for all of your investments. It gets even worse if you sell a portion of your investments. If you’ve been continually reinvesting dividends, some of them will be treated as short-term gains (or losses) and others will be treated as long-term gains. Federal law requires brokers to calculate these figures for you and to provide them to you during tax time.

Advantage: Brokers

In the end, you need to consider all of these factors and do what is best and most comfortable for you.