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DROP BY DROP: DRP strategy has backers
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Published: November 8, 2009
CHICAGO -- Devotees of dividend reinvestment plans, a favorite strategy of do-it-yourself investors, have had their faith tested over the past year.
They may yet get their rewards.
DRIPs, or DRPs, have long been touted as a savvy and inexpensive way to buy into the market for long-term benefits.
The plans are a service offered by hundreds of companies with a couple of big benefits for small investors. First, they enable you to bypass brokers and their commissions to buy stock directly from a company at little or no cost, typically on a monthly basis. Second, rather than cutting you a check, companies reinvest your dividends to buy more stock in your account. They allow for fractional share purchases, so your $3 dividend can be used to buy 0.3 shares of a $10 stock.
The idea is to build stakes gradually through small, regular payments at minimal cost.
It seemed like a nearly foolproof way to accumulate wealth until the market crumbled from 2007-09, erasing years of gains when the Standard & Poor's 500 fell 57 percent in 15 months. The wisdom of buy-and-hold investing came under question, with stocks falling behind even plodding bonds in returns over the past decade. Some pundits said that the financial world's volatility requires a more hands-on investing approach.
What's more, dividends came under fire. Some 75 companies have reduced their dividends over the last year -- more than in the previous five years combined -- and 16 suspended them. The total amount of dividends cut so far this year by S&P 500 companies is a record $47.8 billion.
Investing in dividend-paying companies for the long haul still makes sense, however.
One reason why DRIPs are good in the current market is they prevent "investing paralysis," says Vita Nelson, the editor and publisher of The MoneyPaper, a financial newsletter that champions the plans.
No matter how scary the market, she explains, a DRIP investor is never entirely on the sidelines since dividends are automatically reinvested. Also, market volatility is less of an issue because DRIP investors tend to invest regularly, ultimately evening out the bumps in the market's ups and downs.
Here are five reasons to consider a DRIP plan now:
1. Avoid market timing
DRIPs are the antithesis of a market-timing strategy (buying high, selling low), since there is no single purchase date or price. Dollar-cost averaging spreads investment dollars and pricing risk out over time, avoiding the all-too-frequent tendency for people to buy near a market top and sell near a bottom. Given the long-term upward trend in stocks -- the last decade excepted -- an investor's costs end up being much lower than the value of the shares accumulated.
2. Bets on a dividend comeback
While the recent cuts will shrink dividends for the time being, that won't make much of a difference in a DRIP investor's total shares in a company. And they will come back.
Many of the corporations that reduced or suspended their dividends are likely to increase or reinstate them when they are confident they have stable, predictable earnings again.
3. Reduces costs
You will be able to keep your costs down at a time like this by reinvesting dividends when shares are low, meaning your checks of $50 or $100 will go further and buy more shares than they would have otherwise. DRIPs also generally help investors keep expenses down through their minimal transaction costs.
4. Forces savings
Once the initial groundwork is done, it's easy to let your bank automatically debit as little as $25 a month to go to one or more company DRIP plans.
5. Avoids emotion
The unemotional investing approach required by a DRIP can help lessen stress as well as improve returns. The process forces investors to keep sinking money into stocks at times when shares are tumbling and they might not otherwise be so inclined.
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