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A well known investment vehicle for dividend investors is the dividend reinvestment plan (DRIP). It is debated frequently on Seeking Alpha, however, whether or not this is the best methodology for growing dividend portfolios. In this article we will look at the reasons why it is a sound strategy and good tool for investors.

DRIP Characteristics

  1. Very low fees
  2. Automatic reinvesting of dividends
  3. Easy automatic investing / contributions

Who Should Use A DRIP

A DRIP is a great tool for are investors looking to be passive in their investing style but still build positions of individual stocks. Most individual investors use passive vehicles like 401(k) plans and because of the popularity of diversification, own baskets of stocks and/or mutual funds.

For someone looking to get into specific stock ownership, a DRIP is a great way to do it. A relatively new investor can ease into individual stocks by contributing a small amount of money on a monthly basis into a DRIP and reduce the risk of buying a big chunk of shares at one time at an overvalued price.

401(k) participants that like the automatic nature of such a plan, but again want to invest in specific stocks and/or build a portfolio outside of their retirement accounts, might find DRIPs attractive as well.

Additional Observations

Having participated in DRIPs for many years, I have recorded a few other anecdotal observations that frequently come with DRIP participation.

First, I think many investors may be more "loyal" to a company if they are locked into a DRIP plan that regularly contributes money into the same stock. Now, before I explain, I don't believe in loyalty to a specific stock, but on the contrary, believe you should always stay skeptical of the stocks you're getting attached to. The "loyalty" I'm describing is more about consistency and thus a more intense focus on the company. This more intense focus can often lead to better research and getting to know the company much better. These are good ramifications of loyalty and can enhance frequent DRIP participation on a certain stock.

A second ramification of DRIP participation is often that there's less trading in an account which is a good thing for the majority of investors. Locking into a DRIP is more of a commitment to a stock where if you're just buying stocks at random in your account, you will likely be "looser" in your allocation of funds and not stick to a system or strategy as much. This isn't always bad, but I do believe most investors probably move in and out of positions too much. Focusing on dividends helps, and implementing a DRIP helps even more.

Lastly, many investors utilize DRIPs for core positions and not for other positions. You can use DRIPs selectively and not for an entire portfolio. Currently, I have DRIPs for only McDonald's Corp (NYSE:MCD) and Wal-Mart Stores, Inc (NYSE:WMT) but buy and hold plenty of other stocks.

Conclusion

DRIP plans help with investor discipline. If an investor is seasoned and therefore capable of completely separating emotion from investing, they may not need a vehicle like a DRIP. There are reasons why you may want to avoid a DRIP (which I'll describe in my next article), but for any investor with less than ten years of investing experience, I think DRIPs can be excellent tools that can facilitate disciplined investing and help new investors research specific companies. Also, it's a very low risk and easy way for investors to get used to buying individual securities.

Disclosure: I am long WMT, MCD.

Source: The Case for Using a Dividend Reinvestment Plan