Scottrade's Innovative New Investment Service
Scottrade recently rolled out a new service that any stock investor should be aware of. If you are an investor, you know that part of the cost associated with investing are the commissions on the buying and selling of stocks. Scottrade, a low cost brokerage firm (with trades costing as little as $7/trade) has added the ability to purchase shares of stocks for free, within their new Flexible Re-Investment Program (or FRIP). This game changing program will allow you to build your portfolio month after month for no additional cost to you.
Reinvesting your Dividends
Some stocks offer a Dividend Re-Investment Program (DRIP) directly with their company. For example, General Electric (GE) will allow you to reinvest your dividends rather than get paid cash for those dividends. The benefit to you is GE will purchase those shares from their own company store, which usually means you can get the stock for a slightly lower price. The benefit to GE is they get to keep the cash that would be taken from them when you cash or deposit that check. It ends up as a win-win.
The downside to a program like this is you need to register with every company you own shares in to take advantage of this program. Each program will have its own limitations and requirements, and some of these programs have a separate cost associated with them. In addition to that, the dividends will only be reinvested in that specific company. This doesn't seem like much of a downside. After all, you must feel like this is a good company to invest in, or you wouldn't be investing in it (or, rather, you shouldn't be investing in it). However, it is still not very flexible.
Scottrade has created a better option to the DRIP they refer to as the Flexible Re-Investment Plan (or FRIP). The concept of the FRIP is the same: take dividends your stock shares earn and reinvest them in stocks on a periodic basis. The implementation, however, is much more 'Flexible' and can allow you to automate your stock purchasing in a way that helps build your portfolio over time.
The program allows you two levels of control. First, you can choose which stocks can participate in the FRIP. You get to choose which dividend paying stocks you own will add to the FRIP pool and can make changes to the program on a regular basis. Second, you get to choose which stocks will be purchased with the FRIP. You are not limited to purchasing shares in the companies paying the dividends. You don't even have to choose a stock you currently own! You even get to choose how often trades are performed (Monthly or Quarterly) and what day of the month the purchase is made (1st to the 31st).
An added benefit to the program is these dividend trades are commission free, which keeps your share purchase costs lower.
How the FRIP Works
First, you have to accept the FRIP terms and conditions within your Scottrade account. Once you have read the necessary disclosures and accepted the terms, you can put the FRIP into action.
Second, the FRIP will provide you with a list of all eligible dividend paying stocks. These stocks will continue to receive dividends from the individual companies, but the funds will not be deposited into your trading account. Instead, the funds will be segregated for use in the FRIP. You also choose whether new shares should be purchased Monthly or Quarterly, as well as the day of the month they will be purchased.
Third, you choose a list of stocks (up to 5) and the what percentage of the FRIP dividends will be invested in those individual stocks. Unlike the previous list of stocks, these stocks do not need to pay dividends to be part of the program. You do not need to divide the percentages evenly, and could even set up one stock to a percentage as low as 1%. Understand, however, these purchases occur in an all or nothing block, so if you set a purchase percentage too low, you may be waiting a while for the purchase to occur.
The dividend paying stocks I pick are irrelevant for this example, so let's simply say I earn $100 in dividends every quarter. For my stock purchases, I pick two stocks (we'll use Apple and GE) and I choose to split them up 50%/50%. Now, let us say that Apple is selling today for $500 and GE is selling for $30 per share. Every quarter, $50 is put aside to purchase Apple and $50 is put aside to purchase GE. This is enough in dividends to purchase a single share of GE every quarter. However, the shares are purchased in a block, so no shares are purchased until I have collected enough money to purchase at least one share of Apple. So, in this example, 10 quarters (2 1/2 years) later (GE is still $30/share and Apple is still $500/share), my dividends will purchase 1 share of Apple and 16 shares of GE. So, if you set Apple to be only 1%, it would take you 500 quarters, or over 40 years, to purchase 1 share of Apple (of course, on that date you would also purchase 1650 shares of GE ($99 x 500 / 30)).
Then What Happens?
Once you have enough saved in your FRIP to purchase at least one share of every stock you chose, Scottrade will purchase as many shares as they can of all the stocks in your FRIP list. Whatever cash remains will be set aside until you collect enough dividends for the next round of purchases. If your new shares are also part of the dividend production, then next month/quarter/year, you will add those dividends to your pool. This will allow you to either purchase shares faster, or purchase more shares every round. It allows your investing dollars to work like a snowball that rolls down the hill, getting bigger and bigger the longer it rolls.
Again, the other advantage of these purchases is they are commission free, so in the case of Scottrade, you save the $7 cost to purchase those shares.
I would recommend that you NOT do this in a non-retirement account, however (unless you have quite a bit of stock holdings). When you buy and sell stocks in a non-retirement account, you will pay taxes on the gains of those sales. If you are purchasing new shares every month (which is possible if you have enough incoming dividends), then you have to keep track of every purchase cost to determine your capital gains when you go to sell those shares. If you bought a single share every month for 2 years, you would have to show 24 separate cost basis (or, calculate an average and hope the IRS agrees with your calculation).
The FRIP is ideal for a retirement account, however, where the IRS does not care how many trades you perform (or even if you made money on those trades). They will simply look at how much you withdraw from your retirement account and whether that withdrawal is taxable or not.
If you want to automate your stock purchases and grow your portfolio, then Scottrade's FRIP program may be the program for you. It gives you the advantages of lower cost trades and the flexibility to purchase the shares of your choice.