Alexandria, VA (May 27, 1998) --Today we'll address some of the advantages of dividend reinvestment plans. If you know most of the benefits already, these will serve as a reminder and might even inform you of some advantages that you hadn't thought of. If you're pondering using Drips more often, or for the first time, or giving them as gifts, this will certainly help you decide. You might even print it and give it to a friend.
There are so many advantages to Drips, let's share them and explain what they mean.
1. You Need Little Money To Start and To Continue
You can begin investing in Drips for well under $100, depending on the stock that you want to buy. Most Drip plans require that you own only one share of stock to begin, meaning that if you have $60 to buy your first share of Campbell Soup (and about $20 for fees), you can buy that share and then enroll in the company's Drip plan. That's all it takes.
The plans are also incredibly inexpensive to keep up. Your additional investments in Drips are voluntary and usually commission free. When you do invest additional funds, most plans don't require investments of more than $50, if that. Many plans, as mentioned, require a minimum investment of only $10 to $25 whenever you choose to invest. This means you can invest in a giant company such as General Electric even when you can't afford entire shares -- you can buy partial shares. With GE, you can invest as little as $10 per month when you choose to.
So how frequently should you invest? Ideally, if you've read the "13 Steps to Investing Foolishly," you know that we advise you to pay off all of your credit card debt before beginning to invest in the stock market. This is true with Drip investing, too. Once you clear these debts, you should be able to send money to your Drips every month or quarter, as is intended. To truly build wealth over the years takes saving money, consistently -- ideally 10% of your salary or more, perhaps spread into your 401(k), Drips, and other Foolish investments. You might be surprised at how large a small, regularly invested amount of money can become. And if you're sending just $50 or $100 per month, you probably won't even miss it.
2. Commission-Free Investing
This advantage probably can't be repeated frequently enough. Once you've begun a commission-free Drip, you're potentially finished with paying commissions on your investments for a lifetime. Forever. Some plans do charge fees -- you'll want to try to avoid those -- and most plans charge nominal fees for the selling of stock. There's no way to avoid that. But the point is to buy stock regularly, every month if possible, in amounts that you can afford and without any additional cost at all. That's a wonderfully Foolish thing. As for selling stock? Hopefully by the time that you do decide to sell any of your positions, the nominal selling fee will be the very last concern on your mind. You'll be selling from a yacht off the coast of Barbados. You'll have pirates to worry about.
3. Dollar-Cost Averaging
Intertwined with advantages number one and two is the ability to dollar-cost average into your investments. What does this mean? This is the process of buying stock consistently over the years in equal dollar amounts every month or quarter, resulting in a process that has you buying shares at various prices over time. This means that you're buying more of the same stock when the price is lower, and less of the stock when the price is higher, meaning that the cost-basis for your shares will favor the low-end of your price ranges over the years.
You've heard of stock diversification, which means that you invest in more than a few stocks so that you're safely diversified by industry. Dollar-cost averaging, if you're buying the right companies, can be even more meaningful than that because it is a form of time diversification. In a volatile stock market, you're much less likely to sweat the wide variations in stock prices if you know that, no matter what, you're consistently buying more stock the next month and over the coming years. Just as a Fool should consider investing his or her 401(k) money into the S&P 500 on a paycheck-to-paycheck basis, you should fully utilize the dollar-cost averaging advantages that Drips offer. If you're just beginning to invest in Drips, you might even want to cheer your stocks lower, so that you can buy more shares in your early investment years and build a larger base at lower prices.
This type of unconventional thought -- cheering your stocks down -- is perfect for Foolish long-term investors. Warren Buffett reminds us that we wish for lower prices on cars, houses, and appliances -- so that we can get a better deal. Long-term investors should hope for lower prices on stocks, as well, especially Drip investors who are dollar-cost averaging and have a time horizon that stretches into an era where bell bottoms might have come back in and out of style once again -- meaning, a long way out. Dollar-cost averaging is the perfect way to take advantage of stock fluctuations (without even trying to), while building a portfolio over the years.
As you can surmise, dollar-cost averaging wouldn't be nearly as possible without numbers one and two -- the minimal monthly investments required with Drips and the commission-free nature of most plans. Buying more stock in your favorite companies every month through a traditional broker is a challenge. For most people, even the commissions of a discount broker would prove too substantial over the months and detracting from their portfolio's performance. And if you were forced to invest at least $500 whenever you invested in General Electric, you probably couldn't invest every month and you would lose some of the benefits of dollar-cost averaging. But just $10 per month is the minimum that the GE Drip plan requires -- heck, you can find $10 underneath your kid's... well... in that wallet-thingy that he throws on the kitchen table all the time. You know what I mean. Dollar-cost averaging is one very important advantage of Drip plans. In many cases, an investor who dollar-cost averages into a stock outperforms an investor who simply buys a bulk amount and holds for years. Drips make this process possible -- and easy.
4. Ability To Diversify Easily
You frequently hear that you shouldn't invest in stocks unless you are diversified, meaning that you need to be able to buy at least a small handful of stocks in several different industries before you should even consider investing in individual stocks. The Foolish take on this belief is not much different: If you are moving away from the S&P 500 index fund, you might next invest in the Foolish Four. To utilize the Foolish Four, you buy four of the highest-yielding, lowest-priced Dow Jones Industrial stocks. Buying four of these companies is diversification indeed, as most of these companies are giant conglomerates with several different business operations. To buy four of these stocks in meaningful amounts, though, takes at least $4,000.
But even if you have just $400 you can start your investing career well-diversified if you start with Drips. With $400 you're able to begin investments in four companies with Drips that require only one share of stock to start (if the stock prices are below $100 and after the minimal start-up costs required to buy the first share of each). With just $500 you can begin by investing in five different industry leaders, like Coca-Cola, Intel, Johnson & Johnson, Campbell Soup, and General Electric. As an example, that could be a powerful, very well-diversified portfolio to begin your investing career.
Before you begin to invest in Drips, though, know the amount of money that you can invest into your companies on a monthly or quarterly basis. That should help guide you in deciding how many initial purchases you should make, because you do want to be able to invest in your holdings on a regular basis, at least every quarter, and if you own too many positions some will be neglected. In relation to that, be extra careful not to over diversify. Too many people learn how inexpensive and easy Drips are and they load up, before long having Drip accounts with twenty-eight companies and an amount of record-keeping that could choke a whale. Worse than that, though, is that they can't possibly keep current with the news and situations at all of their companies, even if they can send all of their companies investments on a regular basis, which is also highly doubtful.
We recommend your portfolio be only as large as you can reasonably handle, and by "handle" we mean that you should understand each of the companies that you own and you should be current with each company's latest news. This Drip Portfolio doesn't intend to own more than eight companies in its twenty-year lifetime. Even five carefully chosen companies can have you well-diversified for a lifetime. We've found that twelve to fifteen stocks is the highest amount that a normal individual with other responsibilities can reasonably monitor -- and even that borders on the high side.
5. Reinvestment Of Dividends
We've covered some key advantages of Drips, including the need for very little money to begin and then continue with the investment approach, commission-free purchasing of additional shares, the ability to dollar-cost average into your positions (time diversification), and the ability to easily diversify by industry because you're able to buy as many as five different companies even if you only begin with $500. So, we've covered several topics, none of which have anything to do with the name of these programs -- Dividend Reinvestment Plans.
The final advantage that we'll share is self-evident. It's the ability to reinvest all of the dividends you receive from your companies without a second thought, meaning that you use your dividend payments to buy more stock. This is much better than receiving a $3.44 check from Johnson & Johnson that you misplace and find six years later behind the freezer in a pile of Freeze-eee Ice wrappers.
The reinvesting of dividends -- even meager dividends at the start -- over time will usually separate the incredible investor from the merely average investor. A dividend, when used to buy more stock, is akin to receiving free stock. You certainly didn't pay any money out of your pocket for it. At most, you relinquish your normal dividend check in lieu of additional stock. For most of us, that's not a big deal. (If you rely on your dividend checks, though, don't fret -- there are options to keep receiving them in most Drips). A dividend check has no chance of ever compounding in value once it's been cut (unless you invest it somewhere, after paying commissions to do so), but a reinvested dividend can begin compounding immediately. And not only does it grow in value, but it means that in the next quarter you'll receive an even higher dividend payment than before, due at least in part to the dividend that you received in the last quarter and used to buy more shares.
It's a beautiful thing -- growth on top of growth. It's like an avalanche, except that it doesn't wipe out any towns, skiers, or oil rigs traversing on narrow mountain roads. Tomorrow we'll consider disadvantages.