To get to the root of this, we need to understand the benefits of a Drip. It makes sense to utilize the Drip strategy where it is most effective. After all, you'd rather have Jose Canseco in the batter's box than on the pitcher's mound (if you follow baseball, you know what happened when this power hitter was allowed to pitch).
Drips, as we know, allow us to make numerous small purchases over a long period of time. This ability to dollar cost average allows for a reduction in risk, and therein lies the strength of the Drip. All one need do is to select a good company and make numerous purchases. The vagaries of the market will be smoothed out over time, and one can actually look forward to drops in a stock's price as buying opportunities.
Keeping this in mind, there are two components involved. The first is in regular purchases, and the second is in ensuring that the selection of the company matches your investment criteria. Let's examine these separately -- the former this week, the latter next.
As we read in past articles ("Blind Dollar Cost Averaging" -- Part 1 and Part 2) it seems that the more frequently we make purchases, the less risk is associated with those purchases. Monthly purchases expose one to the market's volatility less than bimonthly or quarterly purchases.
The argument could be made that the purchase price will eventually even itself out, as one occasionally buys when the stock price is high, at other times low. This is true, with the key being the number of purchases made. Our numbers show that more frequent purchases expose you to less risk as measured by volatility.
So we see that the number of purchases made during the lifetime of the investment is one of the keys to the strength of the Drip, and this provides us with the first part of our answer. The benefit is derived through regular purchases, so people should certainly not hold more companies in their Drip portfolio than they can make regular investments into.
This said, several things might influence the number of companies in a Drip portfolio.
For instance, if one holds several Drips with the same transfer agent, one check can be written and sent with the deposit slips in an envelope. This single-step approach makes numerous purchases easy. Ease of execution can promote regular purchases.
Automated Clearing House (ACH) also makes regular purchases easier. ACH allows you to set up automatic transfers from your bank to the transfer agent on a regular basis without any intervention. It doesn't get much easier than that.
A limiting point is the minimum purchase requirement. All companies require some minimum purchase, which can be as low as $10 (Coca-Cola) to as much as $100 (Mellon Financial) or more. An individual with a $100 monthly budget for their Drip portfolio may be limited in this respect. This is why the minimum purchase requirement is one of the factors I take into consideration when selecting a Drip. I want to know if the selection of the company will limit my ability to make regular purchases of other companies.
Next week we will look at the other consideration when determining the number of Drips to hold. To discuss this column, visit us on the Drip Basics discussion board linked below.
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