Introduction to Dividend Reinvestment

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Dividend reinvestment is a systematic method of accumulating shares of a stock that pays a dividend. Many investors use dividend reinvestment as part of a long-term buy-and-hold investment program. After you purchase a stock, simply enroll in the company's dividend reinvestment plan (DRIP) and your dividends will be automatically used to purchase additional shares. Also, you may send voluntary contributions to purchase additional shares. For a mutual fund be sure to check off the dividend reinvestment option on your application form.

Because you pay taxes on dividends, consider putting dividend reinvestment stocks in a retirement account so you can shelter the dividends from your current tax liability.

Examples of Dividend Reinvesting

This discussion includes five examples of dividend reinvestment for stocks owned by Richard Howard. Therefore, we will describe the examples in his words. All the data are actual numbers taken from my dividend reinvestment account statements. The DRIP summary table illustrates the results of dividend reinvesting for one mutual fund and four stocks.

DRIP Summary
Symbol	# Shares With DRIP	# Shares W/O DRIP	Current Price	$ Value With DRIP	$ Value W/O DRIP	% Increase Due to DRIP
VFINX	89.345	58.979	$115.82	$10,347.94	$6,830.95	51.49%
AXP	41.736	39.465	$51.43	$2,146.48	$2,029.68	5.75%
JCI	62.299	53.948	$72.88	$4,540.35	$3,931.73	15.48%
WWY	197.465	158.024	$67.68	$13,364.43	$10,695.06	24.96%
Price and number of shares as of December 28, 2005.

As you study these examples, note how relatively modest amounts of investment dollars produced handsome returns.

Vanguard 500 Index Fund

I opened an Individual Retirement Account (IRA) in 1987 with the Vanguard Group and bought the Vanguard 500 Index Fund (VFINX), which is a low-fee index fund that tracks the S&P 500. The fund pays distributions in the form of dividends and capital gains.

In 1987 I invested $1,513 in eight purchases and bought 58.979 shares. On December 28, 2005 the account market value was $10,347.94. Without the reinvested distributions the account would have been worth $6,830.95. Reinvestment of the distributions increased the number of shares by 51.49% and thus the account value by 51.49%.

American Express

American Express (AXP) is a financial services company best known for its American Express charge card. Its current dividend yield is only 0.9 %. I included AXP here to illustrate the negligible effect that a low dividend yield has on share accumulation. I bought 39.465 shares AXP in 1997 and the account total was 41.367 shares at the end of 2005, only a 5.75% increase in seven years. You don't accumulate shares very rapidly with low-yielding stocks.

Johnson Controls

Johnson Controls (JCI) manufactures control systems and automotive parts. JCI is a growth stock with a multi-year price upside. I invested $1,000 from 1995 through 1997. I have 62.299 shares. Adjusting for the splits, the reinvested dividends have increased the share total by 15.48%.

Wrigley

Wrigley (WWY), the well-known maker of chewing gum, has a steady history of growing earnings and paying dividends. The current yield is 1.7%. Wrigley is one of my favorite companies and I invested $2,600 from 1991 to 1996 to purchase 158.234 shares. Currently my account has 197.465 shares, a 24.96% increase due to dividend reinvestment. And the $2,600 investment has grown to over $13,364.43 primarily due to price appreciation, but helped by dividend reinvestment.

Setting up Your Dividend Reinvestment Account

Here are a few ways to reinvest dividends:

Use a full-service broker. Most brokerage firms let you reinvest dividends for the stocks you own in your account. Ask your broker for details.
Use an Internet discount broker who offers DRIPs (both this and the full-service broker offer the advantage of having all your stocks in one place, which ensures easy record keeping and tax and estate planning). Go to BUYandHOLD, Foliofn or Sharebuilder.
Buy directly from a company. Contact a company through its Web site or a service such as Computershare. Be sure to understand the fees charged by a direct stock purchase plan.
Buy from a subscription service. See the Moneypaper, a monthly newsletter that offers many dividend-paying stocks.
Buy through a bank transfer agent. For example, see Bank of New York. Type dividend reinvestment in the search box.

Always inquire about the fees associated with reinvesting dividends because some plans charge hefty fees. Remember that any fee, no matter the amount, reduces your profits.

For more information about dividend reinvestment read Dividend Reinvestment: Do It, All About Dividends and Mergent's Dividend Achievers.

Also you can read The Dividend Book , a compilation of articles from buyupside.com about dividends and dividend reinvestment. It is a PDF file that you can read for free.

Posted October 2, 2006.