Understand the pros and cons of DRIPs

Understand the pros and cons of DRIPs

Appropriately enough, investors may notice a slow trickle in earnings from "dividend reinvestment plans" (DRIPs). But these investments may end up providing a steady stream of income over the long run.

The concept is relatively simple. More than 1,000 companies and closed-end mutual funds around the country offer DRIPs to their shareholders. These programs enable shareholders to purchase stock directly from the company by automatically reinvesting dividends in additional shares. Many DRIPs also allow you to voluntarily make cash payments directly into the plan to buy even more shares.

Here are some of the main attractions of DRIPs.

*  Most DRIPs don't charge any fee, or only a nominal fee, for purchasing shares.

*  Participants may be able to purchase stock at a discounted price. The discount usually ranges from 3% to 5% and could be as high as 10%.

*  The DRIP may allow you to send optional cash payments (OCPs), often for as little as $10, directly to the company to buy additional shares. OCPs are often used to purchase fractional shares, thereby enabling investors to acquire blue chip stocks they might not otherwise be able to afford.

*  It's easy to join in. Once you've chosen a particular stock, check to see if it has a DRIP. The company will furnish the specifics, including a prospectus and the appropriate application forms.

But that's not to say that investing in DRIPs is without drawbacks. There is a growing trend within the industry to charge a small fee for acquiring shares. Minimum amounts for purchases may be required. Also, the dividends that are reinvested are treated as taxable income, even though you don't currently receive any cash.