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Three Categories of Drips - Part 2

George L Smyth

When I initially wanted to get involved with purchasing stocks about 25 years ago, my interest ended very quickly after learning that the only means of doing this was through a full-service broker, at the cost of around one hundred dollars. No, thanks.

With the advent of the Internet and the cost savings a broker can find through complete automation, true discount purchases have become possible. As of six months ago, it was possible to make a purchase for as little as five dollars. There are now two companies,www.BuyAndHold.com and www.ShareBuilder.com, that not only will make purchases for less than three dollars, but will also reinvest the dividends. It almost sounds like a dream come true, and in some instances, it is.

Before I go any further, I need to explain why I have adopted the "pseudo" prefix, as opposed to the more commonly used "Synthetic Drip." My dictionary offers as one definition of the word "synthetic" to be "not genuine, artificial, devised." Not bad. However, when I think of the term, I think of something like synthetic rubber. This is a substance that is not rubber, but is actually better than the real thing.

Perhaps this is the reason why so many people are confused by the reference to "Synthetic Drip." It would be reasonable for one to assume that not only is this option a replacement for the traditional plan, but also could be better. However, as I'll discuss later, in a considerable number of instances, it's worse.

So, I started looking for another term that would be more descriptive. I chose the prefix "pseudo." My handy dictionary offers the synonyms of "false," "deceptive," and "sham." I am in no way suggesting that this new category of plans fits any of these descriptions. But everyone knows that a pseudonym is not a real name, and these aren't traditional Drip plans, so it seems to fit. It's just my attempt to draw a distinction.

As previously mentioned, the Pseudo-Drip has nothing to do with the company plan. It is merely an opportunity offered by a discount broker whereby fractional shares can be purchased at a reasonable cost, and dividends can be reinvested. The exciting thing about this category is that companies without traditional plans may be selected. This offers the possibility of reducing risk in highly volatile stocks through dollar cost averaging.

The question then becomes "Does it really matter that the purchases are not made through a company-sponsored plan?" The answer is that it really doesn't make much difference where your shares are kept. The dividends will turn into the same number of shares regardless of their location.

But there is an important difference of which one must be aware, and this is the issue of fees. Despite the seemingly low cost of purchase, the fees will add up over time. For instance, if you make three monthly purchases with a plan that charges $2.99 per purchase, your cost for the month will be under $9. However, if those recurring fees had been invested and were making the historic market average of 11% over 20 years, the fees would have cost you $7,764.77. That is significant.

Of course, the fee issue is only consequential if the company has a fee-free plan. If the selected company has either a high-fee plan, or no Drip plan, then the fees are simply part of the equation. It is prudent for Foolish investors to look at all possibilities before making decisions as to where their money will go. Get the Drip prospectus and make an informed decision.