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Articles from The Prudent Investor

Two Ways to DRiP – Part 1

by George L Smyth

There are a couple of good ways to be involved with dividend reinvestment programs, and one bad way.

When I originally started writing about dividend reinvestment programs for The Motley Fool twenty years ago there were three ways to get started with DRiP investing.  The first means of doing this involved companies like BuyAndHold, which ended operations in 2015 and moved their clients to a folio investing solution.

I will not be covering folio trading in this series but will explain what it is, using Folio Investing as an example.

Folio trading allows one to create their own portfolio of stocks on the broker’s platform.  Folio Investing has groups of pre-selected portfolios that one can take as is, or can be modified to accommodate one’s preference to weighting.  Building a portfolio from scratch of specific stocks is also a possibility.

This does come at a cost.  Folio Investing’s least expensive plan sets one back $15 per quarter, plus $4 per purchase.  The basic plan allows only three trades during the quarter, which is a problem for those whose strategy is to make multiple purchases each month.  This limitation can be accommodated on their platform, but doing so moves one to the more expensive plan, which rockets the cost to $29 per month (or $290 per year).

As one who seeks to minimize costs (which is one of the real powers with dividend reinvestment plans), this just does not work for me.

The first way to DRiP that does make sense is to work through a broker, not something that would have been feasible years ago.  This does not fit into the traditional mold of dividend reinvestment programs but achieves its goal in the same manner.  For this example I will look at TD Ameritrade.

The TD Ameritrade website indicates that they offer everything the DRiPper seeks to accomplish.  Their platform advertises fee-free purchases of stock, so multiple purchases of companies could be done each month.  The company also offers a dividend reinvestment program without cost, so that barrier is reached.  And finally, partial shares can be owned.

There may be limitations on these offerings that do not work.  For instance, when making a purchase one needs to specify the number of shares as opposed to the purchase amount.  This means that you cannot purchase fractional shares.  If you wish to invest $100 and the share price is $51 then the $49 will need to wait for another day.  That said, for the advantages TD Ameritrade offers, this is probably going to be an acceptable limitation.

At the time of this writing (10 Dec 2019) there could be a small catch.  TD Ameritrade is going to be acquired by Charles Schwab.  Although I could not find information anywhere on Charles Schwab’s website, I spoke with a representative who told me that they do have an option to reinvest dividends and hold fractional shares, so this may not be an issue.

I have had experience with this in the past.  I originally purchased stocks through a company (long forgotten) that was acquired by Zecco, which was then acquired by Ally.  The reasons for selecting a company to do business with may not be transferred to the new company, so one simply needs to be aware of the situation and be ready to reevaluate their decision.

The second part of this article will deal with the more traditional means of participating in dividend reinvestment programs.

The Dividend Yield and Stock Price Connection

by George L Smyth

Buying for the dividend, in the long term, is also buying for the stock price.

Fads dominate financial magazines.  A quick survey of current editions will often show recommendations of hot stocks and successful mutual funds to purchase right now.  Of course, this year’s successful mutual fund manager may not have this success last into the next year.

The magazine’s stress is on immediacy, which makes complete sense for them.  After all, they need to sell the magazine and next month they will again need to do the same.  Long term purchases are boring and by definition do not need to be changed every month, and that does not sell magazines.

The extreme fad would be day trading.  This has nothing to do with investing and is very stressful.  With immediacy paramount, stocks are purchased and held for mere days or even minutes.  Even if one is able to turn a profit (unlikely, as a study of day traders in Taiwan showed that 80% lose money), the amount of work in simply reporting the transactions to the IRS must be very time-consuming.

The investor's chief problem - and even his worst enemy - is likely to be himself. - Benjamin Graham

For the long term investor the opposite exists.  Whereas day traders only consider factors for the very short term, dividends are important to the long term investor.  One might think that the stock’s value is the only important issue at hand, but ignoring the importance of the dividend is a real mistake.

As an example, $10,000 invested in the S&P 500 in December 1960 would have yielded a value of about $430,000 – not a bad return on investment.  However, the total return including reinvested dividends would have been almost $2,500,000, more than five times greater. 

This shows that not only is it worthwhile to reinvest dividends, but hints that there may be a linkage between price and dividend growth, and indeed this is the case.

The dividend can act as the proverbial canary in a coal mine as far as understanding the health of the company is concerned.  After all, the dividend is real money.  Regardless any accounting tricks that can be employed to obfuscate or deflect accounting numbers in the quarterly report, hard cold cash cannot be denied.

A continually rising dividend rate is a reflection of the fact that the company can at least pay that money to their shareholders.  Companies can only increase dividends when they know that future cash payments will be sustainable.  Companies that cut or suspend their dividend are offering a tell that the future of the company may not be as rosy as they let on to be.

The linkage between a growing dividend and rising stock price not only makes sense, but research bears this out, showing a correlation of close to 90% over 25 year cycles.  So as the dividend grows, the price of the stock is more than likely to move in the same direction.

It is amazing that this is a fact that tends to get lost.  Looking for the next stock tip and hoping to find a clue that will allow one to buy low is a common goal for investors.  However, for those looking to advance over a long period of time, it could be that finding the safety of a dividend is the best long term bet.

This underscores the significance of the Dividend Champions List as a great starting point for one who is DRiP investing to find a company in which to invest.




This website is maintained by George L Smyth