DRIPs: A Powerful Tool

02/20/2014 9:00 am EST

Focus: STOCKS

Charles Carlson

Editor, DRIP Investor

DRIP investing is a powerful tool for investing small amounts of money, says Chuck Carlson, editor of DRIP Investor, who highlights a number of reasons why dividend reinvestment plans can play an important role in long-term portfolio planning.

If I only have $50, I can invest $50 to buy full and fractional shares of stock in a DRIP. Try buying a fractional share of stock via most brokerage accounts.

Being able to invest small amounts of money opens the door to more investment opportunities for me, which increases the velocity of my investing. And putting more money to work more often, even small amounts, adds up big over time.

DRIP investing forces me to buy stocks when they are cheap. Reinvesting dividends means I automatically buy stocks when they are down. Left to our own devices, few of us would buy stocks when the market declines.

However, with dividend reinvestment, you are assured of investing when stocks are offering their best prices, and that can drive big gains over the long-term.

DRIP investing is still, in most cases, the least-costly way to invest in stocks. Sure, the cost gap between brokers and DRIPs has closed over the last 20 years, but DRIPs still offer an edge in most cases.

Even in those cases when DRIPs do charge a fee, the fee will be lower than buying through most brokerage firms.

Where this fee advantage is most readily observable is in dollar-cost averaging, when investors make regular investments in their DRIPs. Investing on a regular basis, by taking advantage of the optional cash purchase features of most DRIPs, is a powerful tool for building wealth.

Low- or no-fee DRIPs provide a big advantage in operating a dollar-cost average program versus doing so via a broker, even online discount brokers.

I've made this statement a lot in DRIP Investor over the years, but it bears repeating: The only way to guarantee better investment returns is to reduce your investment fees. And it doesn't take much in the way of lower fees to generate huge differences in returns over time.

Small gains in annual returns—gains that can be caused partly by reducing investment costs and fees—have a big influence on the future value of a portfolio.

For example, an investor who can squeeze out an extra one-half % per year in returns (perhaps from reducing investment fees) will, in our example, have a portfolio value that is $23,000 to $36,000 greater over 25 years.

And if you can eke out 3% more per year than the investor who earns an average 7% annually—admittedly, no small feat, but not out of the question if you pay attention to investment costs and fees—the difference in returns in our example at the end of 25 years is a whopping $175,589, or roughly 68% more.

The bottom line is that fees matter, and even small fee advantages add up over long stretches of time. DRIPs still offer the best game in town for investing in a fee-friendly way and in amounts that afford you many opportunities to put money to work in the stock market.

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