DRIPs

Recommendations
Another problem with reinvesting distributions is not being able to easily calculate the gain or loss at any time. If you paid $5000 for 100 shares of something that is now worth $6000, the performance of this security is immediately clear. If, on the other hand, you now own 107.338 shares because of reinvested dividends, you have no idea how your investment has done.

A better strategy may be to take all dividends as part of an overall investment plan and place them into a short-term or intermediate-term bond mutual fund or money market fund. Then purchase a larger number of shares in a round lot to reduce the commission per share to a very low level. This will allow for easy tracking of investments while giving up very little of the benefits associated with DRIPs.

IBM Example
Not all stocks offer a dividend reinvestment program (DRIP), and some brokerage firms do not allow the choice. You have to register your ownership directly with the company at the time of purchase. If you choose DRIP, the dollar amount of your dividend is converted into the equivalent value in shares of the company stock. It is rarely whole numbers of shares. For example, IBM currently pays an annual dividend of $0.60 per share. You own 100 shares, and the price of the stock on dividend payable date is $78.95. The quarterly dividend amount to you would be $0.15 ($0.60 divided by four quarters) times 100 shares, or $15.00. If not in DRIP, your account would be credited $15 cash. The reinvested dividend would credit your account .1899936 shares of IBM ($15 divided by $78.95). You now own 100.19 shares with a cost basis of original purchase amount plus $15.

Taxation Issues
When buying mutual funds it is often the default option to have dividends and capital gains reinvested—you end up with more shares of the fund instead of cash. You can choose to receive cash rather than reinvesting, but you usually must indicate this choice to the brokerage firm or the mutual fund company. These distributions are taxed whether you take the cash or the shares. (If tax on dividends is eliminated, as currently proposed by the Bush administration, this all changes. But keeping track of reinvested distributions will be just as important for those with "Deemed Dividends".

Some brokerage firms’ 1099 reports will break down by security the reinvested distributions, but they can only report those details on securities purchased through them. If you sell securities you’ve held a long time, tracking down this data could be a real headache.

Costs Involved
In order to provide capital gains and losses from stock and mutual fund sales for your tax return, you must have exact cost figures. If you have elected to have dividends and capital gains automatically reinvested, you must keep track of each reinvested amount over the course of your holding period. Each new purchase of fractional shares will have its own cost basis and purchase trade date for capital gains calculations. (Commissions and transaction fees can also be added to your cost, as well as deducted from the proceeds figure.)

If you sell all of the stock of a company, you will probably have both short-term and long-term gains/losses. If an average cost method is used, the average purchase price will need to be calculated and used to determined gain/loss. Even if you use a program like Quicken to help you track your reinvestments, the cost of the software and the time and effort to track the required information may offset any gains you obtain.

Introduction
Dividend reinvestment programs (DRIPs) are touted on many Internet sites and advertised on financial news networks. Purported benefits include:

Shares can be purchased at a price that is discounted to the market price for some companies.
Fractional shares, which are not available in the open market, can be purchased.
You can purchase shares directly from the plan administrator thus saving broker commissions.
A disciplined investing program can be implemented via dollar cost averaging.

These benefits can be very real, but they may be more trouble than they’re worth.

Mike Shinn and Linda Stewart for www.fizone.com
March 2003