Last week we asked, "Is four stocks enough?" One of the more commonly asked questions on the Fool discussion boards involves the number of Drip investments that one should maintain. As with most questions of this type, there is no firm answer that will apply to everyone. Just as each individual will differ on the amount of risk with which they are comfortable, so too will they differ on the number of companies to hold. There are, however, some guidelines.
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 needs to 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 regular purchases, and the second is ensuring that the selection of the company matches your investment criteria. Let's examine these separately.
Making regular stock purchases
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 when it is low. This is true, with the key being the number of purchases made. Our numbers showed 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 as to how many to own. 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 company Drips require some minimum purchase, which can be as low as $10 (Coca-Cola (NYSE: KO)) to as much as $100 (Mellon Financial (NYSE: MEL)) or more. An individual with a $100 monthly budget for their Drip portfolio, like the Fool's Drip Port, 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.
Generally, how many Drips you own should be limited to the number of companies in which you can make regular purchases.
Following your companies
The second part of the answer involves the ability to follow a company during the lifetime of the investment. As this is a recurring duty, you must consider how much time you will devote to it.
When you select a company, typically you're committing to making regular purchases over a long period of time. However, this commitment is contingent upon the performance of the company. Just because we are long-term, buy-and-hold investors doesn't mean we turn a blind eye to the goings-on of our companies.
This is one of the reasons we should know why we made our purchase selection in the first place. If the company does not fulfill our expectations, or changes course, then it may be moving contrary to our original intentions. This could signal a reconsideration of the investment.
This occurred to my Kodak (NYSE: EK) Drip. I had selected the company because I felt it would be making real inroads in digital imaging, as the popularity of silver gelatin photography will significantly fade over the next decade. I felt that Kodak had an advantage over other imaging companies with its depth of understanding, not only of the image, but also the technology.
However, I started noticing something I didn't like. Kodak was losing market share to Fuji in the film business, which cut into its earnings significantly. Kodak's suit against Fuji was unsuccessful, so it responded to the earnings problem, in part, by cutting back on numerous parts of the company.
I was seriously concerned when I noted that spending in their Research & Development department had been slashed. This section had always been important to Kodak. It was instrumental in developing its T-grain technology, which not only led to a superior black and white film, but also allowed Kodak to help create the now-profitable APS camera system.
I followed the numbers, and when R&D was slashed for the third consecutive quarter, I realized that the company had strayed from the reasons why I had initially purchased it. I reconsidered and made the decision that it was time to sell my Kodak shares and split the money amongst my other Drip holdings. Note that my concern had nothing to do with the current share price.
This is why I suggest that investors read the annual report and at least scan the quarterly report of each company they own. We must ensure that our companies follow through with the original reasons we had for buying them, and examining the relevant portions of these documents can do this. It can be a rather time-consuming process, and absolutely overwhelming for the individual holding too many companies. However, if you know why you made your purchase, you will much more likely know when it is time to sell, and if you hold only a reasonable number of companies, your upkeep is that much easier.
To summarize, I suggest limiting the number of companies you hold to the ones that you can 1) make regular purchases in, and 2) follow and understand. This way you'll ensure that you're utilizing the Drip strategy for its strengths.
[What if you haven't started that Drip portfolio yet and are still looking to buy your first stock -- or just want to learn more about evaluating companies for investment? Check out our latest online seminar, Choosing Stocks With The Motley Fool.]
George L. Smyth is a long-time Fool and frequent contributor to the Fool's Drip discussion boards, where you can post your thoughts for him if you like (the boards are linked above). George wrote several Drip columns in 2000, which are available in the archives. He owns shares of Coca-Cola. The Fool has a full disclosure policy.