Drips are offered by companies to their shareholders as a way to buy stock directly from the company (usually through a transfer agent) in very small amounts to large amounts, and usually on a monthly basis if desired. The plans also reinvest all or partial dividends paid (it's up to the shareholder) into more stock, thus the name "Dividend Reinvestment Plan."

Now, we know Drip or DRP isn't a very Foolish name, but for now it gets the point across: You're reinvesting dividends, but you're also "dripping" money into your holdings every month, ideally. Drip... drip... drip.... And that adds up over time.

The advantages of such plans are numerous, the most obvious of which being: You don't need a large amount of money to start. You can open an account with as little as one share of stock. Let's look at some other "perks."

Advantages of Drips:

• Drips give a cost effective way for Fools to put stock dividends to a better use -- purchasing more shares of the company rather than simply spending the money or having it sit in a money-market account. Almost all DRPs allow dividends to be reinvested at no fee.

• Most companies allow investors to purchase additional shares through a Dividend Reinvestment Plan for nominal fees -- or often no fee at all. These are called Optional Cash Purchase Plans (OCPs).

• Many Optional Cash Purchase Plans have very low minimum investments, allowing almost a Fool to purchase stock regardless of how much money they have. The amounts to participate can be as low as $10. There are limits on almost all of these plans, although many of them are in the thousands of dollars per quarter range -- well outside what the average Fool could invest.

• Over 100 companies have DRPs that allow investors to purchase stock at a discount to the current market price. These discounts can range anywhere from one to ten percent. This gives investors an immediate return on their investment and sometimes balances out any fees associated with setting up the DRP or buying the stock. Some companies, however, only discount shares bought with dividends, not new shares.

• DRIPs "force" investors to buy stock on a regular basis and hold on to that stock. As a result, investors adopt a long-term horizon and often invest small amounts of money on a regular basis -- money that they usually don't even miss.

Company-run. Many companies take it upon themselves to run their own Drips. These very often are the companies that allow you to buy directly through them without you having to even own a single share, although this is not always the case. The company-run Drips are simply administered from corporate headquarters, normally as part of the overall shareholder relations effort. Some companies go as far as to offer Individual Retirement plans (IRAs) along with the Drip program.

Transfer agent-run. As management of Drips has become more cumbersome, many companies have turned to third-parties called "transfer agents" as a way to make things simpler for themselves. Transfer agents are financial institutions that basically run DRIP programs for a number of companies. Because they can do this for a lot of companies, they can often use the same resources for a number of customers and provide the entire plan at a much better rate than the company could do so by itself. Some of the larger transfer agents include Boston EquiServe, L.P., First Chigago Trust and Chase Mellon. The Moneypaper, which the Fool is using for it's account, goes through the appropriate agent in each stock's case, and allows for a single place to send the initial checks.

Brokerage-run. Some brokerages will allow shareholders to reinvest dividends at no cost, even if the company in question does not have a formal Drip plan itself. However, these brokerage-run plans strictly pertain to dividends only and do not allow any optional cash purchases like an Optional Cash Purchase Plan (OCP) would, and optional cash purchases are a big part of what makes Drip plans so attractive.

Summary

Drips are a way to begin investing with a very small amount of money, and to keep investing monthly (or as frequently as you can afford) in small or large amounts, while avoiding brokerage commissions and reinvesting all dividends, too. In the long-term, it's a great and "patient" way to grow money over time, as you have dollar-cost averaging working for you as well, and you're investing, ideally, in great companies that you can't foresee selling at any time. That's very Foolish.

So how might a Fool begin a Dividend Reinvestment Plan? That's what we'll tackle in the next article!

How to Invest »