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DRIPs vs Traditional Brokerages

 

Is investing through dividend reinvestment plans (DRIPs) worthwhile even when commissions are small or nonexistent in a traditional brokerage account?

 

Saving on commissions has never been the primary reason to use DRIPs.

 

DRIP Investing helps overcome some of the hazards faced by investors. The chief foil to investing success is the tendency to react emotionally to the day-to-day price movements of stocks. Investing is an emotional enterprise. It’s confusing and even seasoned professionals with all their knowledge and charts are tossed around by the market. Should you buy on the dip or sell? You won’t know until it’s too late.


It’s not unreasonable to want to stop losses when stock prices decline. And the ease of action in a brokerage account entices you to do so. With DRIPs, investors establish a plan to build holdings by making scheduled (or unscheduled) investments over a period of years until the dividends alone throw off sufficient amounts to keep the account growing. This subtle difference accounts, for the success-advantage DRIP investors enjoy.


What accounts for the difference?

 

DRIP investors, regardless of whether they are wealthy or have limited resources, can diversify their holdings by starting with only a single share of stock in companies in a variety of industries. And secondly, DRIP investors don’t specify the number of shares they want to buy. Instead, they specify the amount of dollars they want to invest. Thus, they end up getting the number of shares (and fractions of shares) that that dollar amount entitles them to. If you want to end up with a lower cost per share than the average price of the shares during the investing period, you don’t want to be buying the same number of shares on a regular basis—but you do want to invest the same amount of money. The difference will become clear as you read on. (A few traditional brokerages are now adopting measures to provide these two advantages.)


Here’s why those are two critical factors:


Diversifying among market sectors is an uncontested risk-reducing strategy. Diversifying holdings within a traditional brokerage account (where you invest to buy shares, generally in 100 share lots), is more limiting than diversifying among DRIP companies, where shareholder status is all you need to open an account (shareholder status can be achieved by owning even a single share of company stock).


Buy more, low--and less, high.

 

Before you buy your first DRIP stock, we suggest that you calculate how much you can afford to put away for stock investing each year. With that information in mind, you can decide how many companies you should own in your portfolio. The minimum accepted by most companies as an investment amount is $25 or $50. Once you know your budget for the year, you can decide how many companies, how much you will invest in each, and how often. When you invest the same amount of money regularly, you buy more shares when prices are low and fewer shares when they are high (a $100 investment buys only one share when the share price is $100 but it buys five shares when the share price is $20). If you are investing over the long-term, you are likely to be buying at lots of different price points. Always buying more, low, and fewer high! And if you subscribe for membership in directinvesting.com’s DRIP Club, you get INVEST% suggestions that help you buy even more when prices are low and even less when they are high. (I’ll explain that formula-driven investing strategy below.)


The key to success is deciding on your strategy in advance and sticking to it.

 

Perhaps you could accomplish this with a brokerage account. But in my experience, investors, especially small investors, rarely reach their goal investing through traditional brokerage accounts. They save up to buy a stock or two, and if the price of the stock declines, they feel they must preserve what they have left and they sell. We’ve found the DRIP investing strategy to be a very reliable way to accumulate wealth, but any strategy is better than no strategy at all. Otherwise, you will be subject to the forces of the perfidious market.


Why is DRIP investing more reliable?


Time is an important asset when it comes to building wealth. But getting started may seem difficult or frightening. You don’t want to risk losing your hard-earned money. The market may be reaching new highs and you wonder where it can go from here.


As a DRIP investor, much of that concern can be eliminated.

 

The time to start is always right now. DRIP investors don’t have to save up to buy a stock or two. And they don’t attempt to wait to buy at a fair price. And, anyway, what is a fair price? They get enrolled in a DRIP with a single share of the company stock and the one-time service fee. The cost of that qualifying share isn’t important because, after all, it’s only one share!


With DRIPs you don’t really care which way the market moves. It’s great when a stock price advances but stock prices go up and down. When it drops, you don’t worry because your predetermined investment amount will be buying lots of cheaper shares. Your goal is to be accumulating shares in high-quality companies at favorable prices--especially companies with growing dividend payouts. DRIP investing succeeds in helping you do that.


There’s another big difference between DRIP investing and brokerage investing. With DRIPs, the account is held in your name directly on the books of the company just as is the names of the various brokerages. There’s no middleman. There’s no easy access to making immediate transactions. There’s no buying at what you think may be a good price. Often, you don’t even know what the price will be. You don’t consider selling to lock in a profit. The lack of those options may sound like a disadvantage, but after almost forty years of writing about DRIPs and personally investing through DRIPs, I know that those options are the reason why traditional investors tend to fail. DRIP investors have a measure of protection from those options. They can tune out.

 

Try investing $25 at a time through a brokerage account. With brokerage accounts, you buy shares. With DRIPs, you invest cash and get shares or fractions of shares. By now, you may understand why you would want to invest as little as $25. Here’s a recap: You may have $250 a month to invest. Instead of investing in just one company, you can build holdings $25 at a time in 10 different companies. If you are investing in a diversified portfolio, it’s a huge advantage to be able to invest $25. That small amount will bring meaningful results over time. At an 8% return (a conservative estimate based on previous long-term results), an initial investment of $100 and a continuing monthly $25 investment will grow to more than $86,000 after 40 years. After a while, you can add companies to your portfolio even if your income doesn’t grow. That’s because, as the number of shares in your existing accounts grow, the dividend distributions may be enough to replace your contributions. At that point, you can get enrolled in another DRIP company.


I promised to explain how INVEST% works:


When share prices are relatively low, INVEST% causes you to buy even more shares than what your predetermined investment amount would buy—and when they are relatively high, even fewer shares than your predetermined investment amount would buy.


As an example, say your predetermined investment amount is $100 and say the stock price ranged from $26.08 to $39.70 over the past 52 weeks (which were the results for AT&T by November). When AT&T sold for $27 at the end of October, INVEST% suggested that you invest $143.10 (an extra $43). At the end of November, it was selling for $28.74 and INVEST% suggested $130.20. The price went up by about $1.50 so the stock represented less of a bargain (but still a bargain), so the amount to invest went down but was still more than the predetermined amount. Or, using Union Pacific as an example. The 52-week price ranged from about $105 to $211. When the cost per share was $177 in October, the stock was selling closer to its high than its low so the INVEST% was $82 ($18 less than the predetermined $100) and in November, when the cost per share moved up to $204 (even closer to the high), the INVEST% suggested that you invest only $56.70, just a little more than half the predetermined $100. The market price of a stock makes substantial moves based on small and often fleeting events. INVEST% saves you from chasing high prices and helps you take advantage of low ones. (INVEST% does not take into consideration the underlying value of the stock.)

 

-- Vita Nelson

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