How risky are they? I'm already contributing to my 401k plan, but DRPs seem like the easiest way to start investing on my own.
I love DRIP plans for long-term wealth building, though it can be cumbersome to open DRIP plans with multiple companies, which is what you would need to do in order to have anything resembling prudent diversification. A better option might be to open an account with a broker that offers free dividend reinvestment. This way you can keep all of your stocks in one account and monitor them more closely. TD Ameritrade offers this, as do some of the other discount brokers.
And what works for stocks also works for ETFs. You can set ETFs to reinvest dividends as well.
I don't think a DRIP is inherently any more risky, than the actual item you are reinvesting into. All you are doing is taking dividends earned on your investment, and buying more of the investment. Therefore, your overall risk is limited to the risk of the investment itself.
You may want to consider index funds at Vaguard instead. You can purchase the funds in small amounts on an ongoing basis, and have the dividends reinvested. The issue with investing in a dividend reinvestment program is the risk you have in owing one, two, or ten stocks (many of which may have the same return characteristics).
As an example, I am not sure if GM had a dividend reinvestment program, prior to its restructuring, but if they did, and you would have invested there, you may have lost almost everthing. With index funds you can invest in hundreds (the S&P 500) or thousands (the Russell 1000, Russell 2000, or Russell 3000) of stocks thereby gaining diversity that you would not have in just a few stocks.
You can futher diversify by investing in international stock indices.
All of these indices pay dividends too.
As your asset base grows you may want to consider using Index Exchage Traded Funds (ETFs). Vanguard has low cost brokerage accounts. Below is a link to a good article that explains ETFs as compared to mutual funds.
In prior decades when stock trading commissions were $100 per trade or a max of 7% of the investment principal, dividend reinvestment plans were attractive because an investor avoided the purchasing commission cost. An investor still did and does incur the selling commission costs.
Now commission costs are significantly lower.
People tend to place their investments with Dividend Reinvestment Plans (DRIPs) on auto-pilot and forget to scrutinize their investment.
Successful investing is similar to gardening. An investor needs to pull out their poor performers, replant, and harvest their successful investments. An investor needs to think about the economic seasons and the conditions of the investment soil.
DRIPs do not encourage diversification and sustaining an asset allocation plan. DRIPs do create extra tax work in a taxable account.
For my clients in tax differed accounts, I reinvest the dividends from their mutual funds automatically. I also watch the asset allocation of their portfolio, the mutual funds relative performance, the current investment environment, and plan for the anticipated investment environment in accordance with my client’s financial goals.
I don’t take investing lightly and I don’t encourage anyone else to adopt a lackadaisical approach.
I hope you have great success Keenan, Dave
Dividend reinvestment plans are fairly straight-forward and easy to use. As dividends accumulate, the company uses money in the account to buy more shares for you. Mostly these shares come from the company's books and not through another broker. So that's one way they keep the costs down and avoid charging commissions.
You gain the advantage of dollar-cost averaging: buying a few shares each time at different prices. This is one way to take the emotion out of investing and lower your average cost basis in your investment.
The downside was highlighted previously: You are buying only shares in one firm. Even if you could afford to start programs with multiple firms, you then need to consider the underlying risks of that particular company or sector.
Another low cost option is to consider index funds. There are even funds that focus on dividend-paying stocks. You can do a search on the Morningstar web site for such funds.
Another option is to use Exchange Traded Funds (ETFs). You can get all the advantages of an index fund with possibly even lower costs. (Though if you are dollar-cost averaging you will incur trading commissions but most places are very inexpensive).
One such option is from Vanguard with the symbol VYM.
FYI - If you are ever looking for a tool to translate and find the equivalent ETF for a mutual fund, check out www.etfdb.com.
If you're looking for an inexpensive platform for trading ETFs to make this work, consider this: www.FolioInvesting.com.
While reinvestment of dividends is an important factor to long-term success in equity investment, I do not advocate DRIP use. One, in taxable accounts the quarterly purchases can make for difficult cost basis accounting. And two, I would rather investors not "set it and forget it" as I think is often a common pattern in DRIP investing. As others have noted, portofolio holdings should be periodically analyzed & culled if necessary. Besides, you can reinvest your income on your own, into areas that you or your advisor judge as attractive, if you so choose. Good luck!