What If I Can Only Invest a Little Every Month?
Congratulations! If you're investing set amounts of money every month, you're dollar-cost averaging! That simply means you're buying more stock when prices are lower and less when they are higher. Some folks think this is a great way to avoid volatility in the market, because their investments "average out" over time.
So how can those on tight budgets buy stock? Many publicly traded companies have made it easy with DRPs, also known as Drips. (Insert your own joke here.) DRP stands for the very unfunny-sounding Dividend Reinvestment Plan. Drips and their cousins, Direct Stock Purchase Plans (DSPs), are great ways to invest small amounts of money cheaply; they allow you to bypass brokers (and their commissions) by buying stock directly from the companies or their agents.
More than 1,000 major corporations offer these types of stock plans, and many of them are free -- or have fees low enough to make it worthwhile to invest as little as $20 or $30 at a time. Once you're in the plan, you don't even have to buy a full share each time you make a contribution. Most Drip investors buy a set amount of stock on a monthly basis, thereby dollar-cost averaging over the life of their investment.
Here's how it works: Drips allow you to reinvest dividends into more shares of stock, and they allow you to purchase stock in fractional amounts -- meaning that if you want to spend $100 buying shares of Microsoft, you can do so regardless of what the price of one share of Microsoft may be. So, if Microsoft is selling at $75 a share, you'll buy 1.33 shares of it with your $100; if the stock is selling at $125 a share, you'll get 0.8 shares for the same amount.
Many Drips will set up an automatic payment plan for you, so you never even miss the money you're setting aside for your future. Dripping for dollars can be one of the surest, steadiest ways to build wealth over your lifetime (just make sure you keep good records for tax purposes).
But what if you want to invest in a company that doesn't have a Drip plan? Some brokers offer many of the same services as regular Drip programs. Companies such as ShareBuilder, FOLIOfn, and BUYandHOLD.com allow you to set up Drip-like accounts where you can buy shares of any of 4,000 stocks (and many index funds) with low transaction costs.
Make sure you understand how these plans work and their particular quirks. For instance, BUYandHOLD currently has a monthly minimum. ShareBuilder has a higher charge to sell a stock. That's not going to be a problem for Drip-type investors, but it's something to keep in mind if you think you'll be an active trader. Also, as with Drip investing generally, the share purchases for any of these brokers are not necessarily made according to your schedule -- although all offer real-time trades for those occasions when you need to act quickly.
To evaluate whether these services are good deals, let's consider the Foolish maxim of not allowing your trading cost to exceed 2% of your total transaction. The lowest fee available from ShareBuilder and FOLIOfn is $4, so that would mean you'd want to invest at least $200 at a time to stay within the limit (2% of $200 = $4). If you can't come up with $200 each month, though, just stash the cash in a savings account until you get there, and then make the transaction.
Because of the $7 fee at BUYandHOLD, however, you'll need to make sure you invest at least $350 each month (2% of $350 = $7). This certainly makes the service less attractive for many Drip investors. Unless you'll be pumping $4,200 a year into the plan, your costs will exceed the 2% ceiling.