Building a DRIP Portfolio

It's Easier than You Think

Whether you're just starting out or have been investing for a number of years, you may think that creating and maintaining a stock portfolio is a daunting task--one you might better leave to the professionals. The truth is, however, that you can minimize investment risk and cut your investment costs by doing it yourself. The process is not as difficult as some would have you believe. In fact, it can be fun.

Regardless of one's age, investing can trigger emotional reactions that lead to mistakes, so the most important trait needed is patience. After all, investing is a long-term...even lifetime...pursuit. That fact has been lost on many individuals who have witnessed countless reports of Internet millionaires and a barrage of advertising by online brokers. The unfortunate side effect is that many people honestly see no difference between day trading and investing. Before you embark on building a good portfolio, then, it's necessary to remind yourself that doing so involves long-term thinking, not instant gratification. And if you already have a portfolio, it may be a good time to examine how well it meets your current and long-term needs. The traditional advice to review your portfolio at least once a year still holds true, both because your companies may have changed and because you may have changed.

Buy What You Know

Choosing your first stock can be difficult enough, but you also may realize that it's necessary to spread your risk among a group of stocks. "Don't put all your eggs in one basket" is the conventional wisdom, but it's also good advice for those who have become aware of the need to invest in stocks for the long haul, often in conjunction with retirement planning. Unfortunately, the prospect of choosing five or 10 stocks is intimidating to many people. That's why so many opt for owning a mutual fund and abdicating the responsibility. But mutual funds have their drawbacks, including unnecessary fees, poor performance, and a short-term focus. Worse, they may saddle their investors with unwanted taxable capital gains distributions (that can occur even when the fund is down). And they may be left clueless about the companies owned by the fund.

Picking stocks for a good portfolio doesn't need to be intimidating. Even legendary fund manager Peter Lynch, who once ran the largest mutual fund in the country at Fidelity, has stated that individuals really have the advantage over fund managers. He urges people to start by "buying what they know" and holding for the long term. DRIPs give people an additional advantage. Since you can invest through a DRIP without going through a broker, you can invest small amounts on a steady basis, rather than having to save up several thousand dollars and risking it all at once.

"Buying what you know" simply means investing in the companies whose goods and services you...and millions of other consumers...use daily. Of course, that's just a starting point, but, as the saying goes, "a journey of a thousand miles begins with one step." Combine this idea with the concept of owning a handful of basic industries...such as food, banking, oil, utilities, and health care...and building a portfolio may begin to seem manageable, even easy. What these industries have in common is that they provide goods or services that people need on a steady basis, making them somewhat recession-proof. Chances are that you can find at least one company in each of these industries that is familiar and is enjoying a lot of "repeat" business.

Making Choices

If identifying familiar companies is the first step, then the next is to determine which competitor represents the best investment. Remember that you're focusing on the long term, not trying to "bet" on a company that may surge over the next weeks or months. If you feel the need to do that, it's best to use separate funds that you devote to short-term trading. The shorter the time span involved, the greater the risk you're taking if you're betting on quick profits. But that's not something you want to do with your retirement funds! Investing for long-term goals, such as retirement or college funding, requires discipline and, to some extent, a more conservative approach. Be wary of becoming too conservative, though, as this form of psychological inertia can lead you into locking yourself into mediocre returns. Starting with leaders in several basic industries can help avoid this, especially when you add top companies from a few other industries. It's a good idea to start by comparing basic industries, using data from such sources as the Value Line Investment Survey, available at most libraries, or utilizing the plethora of online information sources, such as Yahoo! Finance or MSN's MoneyCentral.

Some common sense should be applied to stock selection. For example, companies that are laden with debt will have a hard time growing profits, just as individuals with hefty credit card balances will have a hard time saving any money, let alone investing. (Certain industries are exceptions, however, such as utilities that must borrow heavily to build new power plants, and banks, whose liabilities include depositors' money.) Debt-laden companies not only must devote more of their operating profits to interest expense, but are also vulnerable to interest-rate hikes. Another basic yardstick is a company's price/earnings (or P/E) ratio (the stock's price divided by earnings per share). Unloved stocks will have lower P/Es than ones that are enjoying great popularity at the moment.

Investing for the Future

Stocks are often segregated into "growth" and "value" groupings, each with its own appeal. Growth stocks typically are increasing revenues and earnings at an above-average rate, but pay little or nothing in dividends. By contrast, value stocks have slower...albeit steady and reliable...growth and pay more in dividends. As a growth stock (and its industry) matures, its rate of growth may slow, so it rewards its shareholders by increasing its dividend to offer a higher yield. In the late 1990s, growth stocks were in vogue, causing some to criticize their high P/Es, which suggest that investors are more vulnerable to any misstep a company makes. Value stocks were out of favor, as indicated by their relatively low P/Es and higher yields. (Yields in general had declined for both groups, partly as a result of more favorable tax treatment for capital gains, compared with dividends, which were taxed as ordinary income.)

Investing for the next several decades will require two commitments: getting started now and investing regularly over the years. As mentioned earlier, many people give in to the inertia of indecision and a feeling of helplessness, so they simply don't get started. But as we've said, you are the best analyst you can find and, considering the track record of many mutual funds and market "gurus," you're likely to do at least as well as any "experts." Buying the first share in order to enroll in a DRIP should help kick-start your investing experience. Once you have a DRIP statement (and the tear-off portion for additional investments) in hand, it's far easier to get going. Hundreds of companies even let you set up automatic debits from a bank account, so there's no excuse...even for the person who hates to write checks...for delaying the accumulation of wealth to meet your long-term goals. If you have very little to start with, you can begin with one DRIP and add others periodically until you have a diversified portfolio. Otherwise, starting with a handful of basic industries and adding others later will do the trick. You can find out more, and become enrolled in DRIPs, by calling 1-800-388-9993, or online at www.directinvesting.com.