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Dripping With Fees

George L Smyth

Selecting a stock is the result of a great amount of research. One not only needs to understand the company -- what it does and how, who is in charge, etc. -- but also the company's financial structure. This task cannot be done quickly or simply.

Determining that a company has excellent growth potential and should be added to one's portfolio allows a comfort level that will help sustain the long-term investor and keep him or her invested through the bad times -- bad times that are temporary at an enduringly good company. Overall, the decision to make a decade-long commitment, or longer, to numerous purchases in a stock can and should be rewarding to the careful investor.

The problem with some Drip candidates is plan fees. While more than 700 companies allow purchases in a Drip without a broker's commission, some companies charge small fees for each purchase in a Drip. This poses a dilemma for several reasons.

The Negatives of Fees
The first and most obvious negative is that one's return is diminished by fees. The money that would have gone toward a stock purchase ends up in someone else's pocket. Over time, this loss can be significant. If one pays a $3 charge every month to purchase a stock that returns 16% annually, over 20 years the result is a lost opportunity of well over $5,000 in additional gains.

Another way returns may be diminished is through fees on dividends. These fees reduce the dividend yield that one enjoys on a quarterly basis. This means that, even if you stop making purchases, your returns still take a hit. This is the case with Drip Port's Campbell Soup (NYSE: CPB) holding, although the fee is only $0.36 per year on its dividends.

Less noticeable is the increased risk associated with trying to lessen the impact of the fees. The most common solution to fee reduction is to make fewer purchases -- saving money to make a larger purchase, which will normally reduce the percentage removed from the purchase by the fee.

In a past article, we saw how risk increases dramatically when fewer purchases are made in a Drip. Although less money is taken out in fees, this is done at the cost of increased volatility risk.

I will not argue, however, that the idea of paying fees should be summarily dismissed. If one believes that a company will grow at 20% per year, then wouldn't it be a better selection than a company growing at 14%, even after losing a couple of percentage points to fees?

This is where individual due diligence comes in. Since, generally speaking, the larger the purchase, the less the impact of fees on that purchase, various investors will be affected differently by fees.

I asked Fools on the discussion boards to tell me the fee-based Drips in which they participate. I looked at the fees for the leading responses and created the chart below showing the impact of the fees. The asterisk (*) means that there are additional per-share fees that are not taken into consideration.

Company Fee % on $50 Purchase Fee % on $100 Purchase
General Electric 6.0% 3.0%
Home Depot 8.5%* 2.5%*
Nokia 5.0%* 2.5%*
Lucent Technologies 5.0%* 2.5%*
Merck 10.0%* 5.0%*

If you can make regular $100 purchases, do you think that General Electric will grow at least 3% more than any other non-fee choice you are likely to make? How about the others? Will these companies grow at a rate that will make paying the fees in each Drip worthwhile? In the end, you need to make that determination for yourself.