Dividend Reinvestment Plan or Mutual Fund?

By Dr. Don Taylor, Ph.D., CFA, CFP Features Bankrate.com


Dear Dr. Don,
Would I be better off investing in a dividend reinvestment plan, or DRIP, from my favorite company, or a mutual fund that invests in that company? How can I tell what companies a mutual fund invests in? This would be after contributing up to the limit of my company's 401(k) match.

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-- Tina Trader

Dear Tina,
You own a mutual fund because you want to diversify your investments across companies and gain access to professional investment management. You buy an individual company's stock to participate in the profitability of that one firm.

If you own a company's stock and want to reinvest the quarterly dividends it pays out to you back into the company's stock -- which is what a DRIP does -- that's fine, although you will have to pay income tax on the dividend income received.

I'm not a big fan of DRIPs as an investment vehicle to own a company's stock. The days of getting a deal in the stock by participating in its DRIP are by and large gone, as are the days of these programs being low-cost. Most DRIPs now have fees and expenses. I'd rather see you open a low-cost online brokerage account so you can invest in any stock. You could even consider one of the discount brokerage firms geared toward new investors who don't have much money to put to work all at once but want to get started investing.

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You can see what stocks a mutual fund owns by reviewing its prospectus, which you should do before investing in any mutual fund, or by reviewing its quarterly filings with the Securities and Exchange Commission. Mutual funds file form N-Q, the Quarterly Schedule of Portfolio Holdings of investment management companies. But note that you'll be looking at the fund's holdings at a point in the immediate past.

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