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Dividends
Dividend Reinvestment Plans
by InvestorGuide Staff (Write for us!)
(Click on the links within the article to get definition of that word)
When the markets are going strong, investors can't seem to buy enough stock to
satiate their appetites.
However, when a bear market appears and the Dow and S&P 500 both dip by 15% or more for extended periods of time,
investors flee, and are unlikely to return if the losses they incurred were substantial.
While this may seem perfectly logical, it can actually be the wrong path to take. The reason is simple:
the stock market continues to be the most stable and reliable investmentoption when a long-termperspective is taken.
In fact, the stock market has grown by an average of 11% over the past four decades.
Were there bad periods where the bears sapped stock prices and caused losses? Sure.
But, if investors held onto those stocks instead of panicking and selling (another way to ensure that stock
prices plummet), they may have come out much farther ahead in a year or two. Therefore, investors may want to
consider an investment option that removes the temptation to sell-off during a downtrend, while still buying stock
in a solid, qualitycompany. Stock dividendreinvestment plans are excellentoptions for investors in the market for
the long haul and who are looking to buy quality stocks for their portfolio.
Dividend reinvestment plans are not managed by brokers or other financialexperts. Instead, these special plans are
actually offered by the same companies that investors are buying stock in. The basic premise of a dividend
reinvestment plan is
to reinvest dividends back into the company. This reinvestment comes in the form of additional
purchases of stock - thus, there are no cash payouts. Such plans even sellfractional shares of stock to
investors, so every dime of profit is sunk back into the company, and the investor then owns more stock.
There are over 1,000 corporations currently offering stock reinvestment plans to investors. Many allow investors
to make weekly investments while others may only allow them quarterly. Companies love such plans, because it affords
them easy access to capital at low-interest rates. The company does not increase its debtburden, but still has
the capital it needs to increase future earnings. Plus, businesses love long-term investors who are willing to stay
for the long-haul, as they help stabilize stock prices, and reduce frequent trading and the associated pricefluctuations.
While larger investments will naturally lead to larger profits (when successful), it can be difficult for many to set
aside large chunks of cash for investing. But, with many corporations (even some of the big names!), an initial
investment of $10-20 is all that is required to enroll in a dividend reinvestment plan. However, it is also necessary
to already own stock in the company to be eligible, but owning a singleshare is often all that is required for
eligibility in many stock dividend reinvestment plans.
Another common problem for investors is attaining large numbers of shares in one specific
company. But, the great
thing about a stock dividend reinvestment plan is that it allows investors the opportunity to buy significant numbers
of shares in a company over a long period of time. During bear markets, investors can buy more shares at a lower cost
while waiting for the bulls to reappear - but the key is to continually buy stock during all phases of the market cycle.
Investors also like dividend reinvestment plans because of their low-cost. By purchasing stock directly from the
company, investors can by-pass brokerfees and buy more stock perunit of money. In time, the additional shares of
stock will contribute to significant gains in the bottom line as long as the stock price does, in fact, rise by
the time the shares are sold.
As often happens in a bear market, people tend to sell off and cut their losses. But with a dividend reinvestment plan,
investors are more likely to not only keep their stock, but also buy more.
Finally, while dividends are reported as capital gains, dividend reinvestment plans do not make any cash payout.
While stock prices may rise, no capital gains taxneed be paid until the stock is sold.
The longer the shares are held, the lower the tax rate tends to be.
Disadvantages
While people like to see their investments grow until they are ready to retire or make a large purchase, it is
sometimes necessary to liquidate in order to meet currentobligations. Unfortunately, stock dividend reinvestment
plans are somewhat difficult to liquidate. It is quite possible that the company will need to be directly contacted
in order to sell the accumulated stock and exit from the plan. Some companies even require written requests from
investors looking to opt-out of their stock dividend reinvestment plan (remember, companies like steady investors
who are in it for the long-haul, so requirements like a written
request are designed to discourage investors from
cashing out of the plan).
Another issue that many investors have with stock dividend reinvestment plans is the fact that they are on
their own. While there are no broker fees with such plans, this also means that there are no brokers helping
investors make investment decisions. It is up to the investors to investigate and research potential companies
and their dividend reinvestment plans. Therefore, to a certain degree, such plans actually carry more potential
risk for novice investors.
Though stock dividend reinvestment plans make it more difficult to liquidate stock, and require more homework on
the part of investors, the advantages make them very attractive for investors who are new to the stock market.
Such plans may forego the potential dividend cash payout but they allow investors to build up a significant stake
in a company over a period of several years. An 11% average annual return on the stock market in the past
40 years is not a myth - it is fact. Those that stay in the market for the long haul are more likely to see
an 11% annual return on their investment than those who bail at the first sign of trouble.
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