Today we review some of the advantages behind investing in low-cost Dividend Reinvestment Plans (or DRPs, which we call Drips). Sometimes I give educational interviews on this topic for newspapers, magazines, and on radio, and the interviews truly are educational, because you realize that so many people still don't know what a Drip is or how it works.
If you're up to speed on this topic and you'd rather read something else, Brian Graney recently sent me a good article entitled, "The Best Investor You've Never Heard Of." Now 96 years old and still investing, Joseph Rosenfield has turned $11 million into $1 billion since 1968. It's an interesting read. (The only part of the article that is disagreeable was its statement that most "normal" people need to spread their assets into many different investments for safety, even though Mr. Rosenfield has only bought a small, very focused handful. We believe in a tightly focused strategy, too.)
Advantages of Drips
You don't need a lot of money to start and to continue
You can begin investing in Drips with less than $100. Most of the existing 1,200 Drip plans require that you own only one share of stock to begin (a full list of plans and requirements is in the Fool's Drip book). You only need enough money for your first share of stock, plus about $15 for the stock certificate delivery to get started. Drips are also usually free to keep up. Your additional investments in Drips are voluntary and, depending on the plan, they're typically completely free.
You can purchase fractional shares
You can buy fractional shares of a stock in Drips, meaning that you can invest very small amounts of money and buy even less than one share if need be. That's great for small investors who want to regularly buy large, leading stocks each month.
Dollar cost averaging
Dollar cost averaging is the process of buying stock consistently over time, typically in equal dollar amounts every month. This means that you're buying shares at various prices over time. Doing this, you'll buy more shares of a stock when the price is lower, and fewer shares when the price is higher, meaning that the cost basis for your shares will favor the low end of the price range over time.
Dollar cost averaging does work to lower your risks. In a volatile stock market (as we've had for two years!), you're less likely to sweat price swings if you know that, no matter what, you're consistently buying more stock each month. Knowing this, you may even cheer your stocks lower in the near-term so you can buy shares at lower prices. Dollar cost averaging is the perfect way to take advantage of stock fluctuations (without even trying to), while building value.
Most Drips are entirely free of commission charges when buying additional stock and reinvesting dividends. Enough said!
This typically free service can build substantial wealth over time. Some brokers have begun to offer this service, too (even allowing for fractional share purchases with dividends), so this isn't an advantage exclusive to Drips, but it is a good benefit.
Ability to diversify easily
If you only have $200, you can still start your investing career being well-diversified if you start with Drips. With $200, you're able to begin investments in four companies in Drips that require only one share to start. With only $200, you can begin investment plans in Pfizer (NYSE: PFE), Coca-Cola (NYSE: KO), Intel (Nasdaq: INTC), and Mellon Financial (NYSE: MEL). From the start, your money is diversified, but not over-diversified.
We recommend that your portfolio be only as large as you can reasonably handle, meaning you should understand each of the companies that you own and you should be current with each company. You should also be able to invest in each stock regularly, or you'll sacrifice the benefits of dollar cost averaging.
A disciplined investing framework
As a Fool who has had both a discount brokerage account (that link goes to the Fool's Discount Brokerage Center, if you want to shop for one) and Drips, my Drips taught me a great deal about how I should invest in the discount brokerage account: namely, buy to hold! At times, holding stock is very difficult to do in a free-wheelin' brokerage account, and I end up making mistakes. Drips, on the other hand, have never allowed me to make a selling mistake. These steady plans are structured to provide discipline and to make you think and invest rationally over long periods of time. The benefits of this disciplined framework can be tremendous for beginning investors -- and for seasoned ones.
New Complements to Drips
New brokerage services, namely BuyandHold.com and ShareBuilder.com, provide all of the above benefits, too, except for one key advantage: They do charge commissions, and even though it's only a few bucks, they'll add up. These programs are still well worth consideration, though, especially to buy companies that do not offer Drips -- meaning thousands of companies.
If you can buy a company through its free Drip, that's the most economical route. If a good company doesn't have a Drip, and you want the many advantages of Drip investing listed above and are willing to pay some commissions, then these plans may be a good complement to your Drips.
For more on Drips, see our related links above. To discuss them or to ask questions, visit us on the Drip boards, also linked above.