Find out why DRIP stocks are the key to that easy money everyone dreams about.
Look at the history of rock and roll, and you’ll find all kinds of songs about making money the easy way. From the prog-rock of King Crimson’s “Easy Money” to Dire Straits’ “Money for Nothing” to “Rich Girl” by Hall & Oates, there’s no shortage of money-themed songs. But you can bet there’s not one out there that mentions DRIP stocks.
That’s a shame, too, because DRIP stocks are the source of literally the easiest money you can make. Granted, it might not have the star power that cash has, so it’s probably not showing up on the Top 40 charts anytime soon. But maybe we can change that. Let’s start by looking at what they are.
What are DRIP stocks?
Aside from the most powerful tool in an investor’s arsenal? A DRIP, or Dividend Reinvestment Plan, allows you to automatically reinvest cash dividends by purchasing additional shares or fractional shares on the dividend payment date. Companies that operate their own DRIPs will often let you buy additional shares of their stock commission-free, and sometimes even at a discount to the current share price.
Thus, the amount of shares you own in a given stock automatically expands every quarter when you enroll in a DRIP, so long as that company keeps paying a dividend. This allows wealth to continue to accumulate as time passes, and more shares are automatically purchased.
What DRIP stocks can do for your finances
First of all, these investments work best with the added ingredient of time. The benefits of DRIP stocks don’t really emerge for short-term investors; they need time to work their magic.
When you reinvest dividends, you increase the size of your investment, thus also increasing the dividends you’ll receive next time. So each reinvestment will be slightly larger than the last (assuming dividend payments don’t decrease). Just as with compound interest, you’ll be surprised how quickly those little additions can add up!
Here’s an example:
Based on a reasonably average return, a child who invests $50 a month from age eight to age 13 (a total investment of only $3,600 over the six-year period) will end up with $1,302,154 at age 65.
The great thing is that you don’t need a lot of money to set up a diversified portfolio of DRIP stocks. You can start with one share of each company and make small investments to buy additional shares every month (or every quarter). By accumulating shares in this manner, you don’t need to speculate about the right time to invest. That’s because your small regular investments will end up buying fewer shares when prices are high and more shares when they are low.
Additionally, since DRIPs are long-term investments and returns automatically reinvest themselves, there is less need for investors to micromanage their accounts.
Despite all these advantages, there are a few reasons you may want to skip DRIPs.
The most obvious reason is that you need the income. If you’re in the “distribution” phase of your investing life, dividends are a perfect source of passive income. So if you’re going to be looking to your portfolio for income every month anyway, it makes sense to have that cash deposited in your account.
You might also choose to stop reinvesting your dividends for allocation reasons. Reinvesting your dividends, through DRIP plans or otherwise, will cause your stock positions to grow over time. If you’ve owned a particular issue for a long time, it may already be a large enough percentage of your portfolio. Higher-yielding positions will grow faster, which can throw your allocations out of whack pretty quickly. So once a stock position is as big as you want it to get (for now), feel free to turn off dividend reinvestment for that position, and either enjoy the extra income or save up the cash to invest in other stocks.
One last word of advice. Like any investment, you don’t want to jump into stocks that don’t fit your investing needs or don’t have promising futures. While DRIP stocks are generally safe, well-respected companies, there’s never a guarantee in the stock market. So do your homework and research the company before you invest.
What is your opinion of DRIP stocks? Do you think they make a big difference in your overall returns?