DRIPs for the Long-Term Investor
Who doesn’t love clearance? Who doesn’t enjoy the high from buying something at an incredibly discounted price?
It’s exhilarating, isn’t it?
This may be the perfect solution for you investment bargain hunters out there.
Dividend reinvestment programs, or DRIPs, are an interesting way to grow wealth and increase shares at a substantially lower price.
Normally when a company pays dividends to shareholders, it cuts a check or opts for direct deposit.
Dividends are great supplemental income, perfect for assisting in everyday expenses or for having a little extra spending money.
However, DRIPs are designed for more long-term growth rather than an immediate payoff.
Dividend reinvestment programs are offered by corporations that allow investors to reinvest their dividends by purchasing additional shares, or sometimes fractional shares, on the dividend payment date, sometimes for 1–10% off the current share price and commission free.
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Although cash dividends are not received by the shareholder, they still must be recorded as taxable income.
Typically the shares purchased through a DRIP program are from the company’s own reserve and are not marketable through stock exchanges.
The biggest long-term advantage DRIPs have to offer are the automatic reinvestment on compounding returns.
So essentially, when dividends are increased, shareholders receive an increasing amount on each share they own, which in turn can also purchase a larger number of shares.
Over time, this increases the total return potential of the investment.
Because more shares can be purchased whenever the stock price decreases, the long-term potential for bigger gains is increased.
For example, let’s take The Coca-Cola Co (NYSE: KO) DRIP into account.
If an investor invested $100,000 in Coca-Cola stock 10 years ago and collected all dividends, their portfolio would only be worth $169,732 today because the stock went up 69.7% during this time period.
However, had that same investor decided to reinvest those dividends into Coca-Cola’s DRIP, their portfolio would be worth $222,412, an impressive 122.4% return on investment.
In order to participate in Coca-Cola’s DRIP, the investor had to relinquish their ability to collect any of the cash dividends.
DRIPs are only successful for those patient enough to see them through the long-term compounding process.
They’re not for everyone.
Some people prefer the cash dividends, and that’s perfectly fine. There’s nothing wrong with enjoying the spoils of a good investment. A DRIP just might not be for you then.
Other great "aristocratic" companies with good DRIPs are 3M Co. (NYSE: MMM) and Johnson & Johnson (NYSE: JNJ).
Both are some of the world’s most diverse businesses, and their high dividends and low volatility make them ideal for DRIP investing.
3M Co. yields 2.7% and has paid dividends for 98 straight years! In 2016, $1.11 million was paid out while maintaining a reasonable 53% payout ratio.
Johnson & Johnson shares yield 2.3% and have been paying dividends consecutively for 53 years. Its payout ratio is 54.8%.
With such modest payout ratios, companies like these are reinvesting capital into research and development, preparing for more breakthrough products and a promise of steadily higher profits.
DRIP investing can make a perfect retirement nest egg or can be an ideal first investment for kids.
For example, if you would like to fund the retirement program of a child or newborn loved one, DRIP investing is a good way to go.
In most instances, the child’s money ends up in a savings account or a certificate of deposit, which aren’t necessarily bad investments, but they’re known for famously under-performing in the long run.
If you invest $4,000 into a DRIP around the day the child is born and never touch the investment again, it will grow to nearly $1 million by the time the child turns 65.
It is also something interesting to watch grow with the child, and it can be a great learning opportunity, too.
Remember the old adage “Invest in what you know”?
That's a good strategy to employ if you decide to invest in a DRIP for a little one.
A child may lose interest in an investment they have no interest in or cannot relate to.
On the other hand, their excitement and interest in the investment will most likely grow the next time they go to McDonald’s, drink a soda, eat a Hershey’s bar, shop at Wal-Mart, or attend a Disney theme park if they can understand that they are now an owner of the company.
The following are companies that make perfect DRIPs for kids:
Coca-Cola (NYSE: KO), Walt Disney (NYSE: DIS), Harley-Davidson (NYSE: HOG), Hershey Foods (NYSE: HSY), McDonald’s (NYSE: MCD), and PepsiCo (NYSE: PEP).
The options for DRIP investing are endless.
Patience is key for success, though, because this is not a strategy that yields immediate results.
The benefits of long-term compounding, as shown from the examples above, are indeed worth the wait.
Until next time,
Pro Trader Today