This is a guest post by Clare from MoneyEnergy, a blog that focuses on dividend investing for cashflow and other topics related to financial freedom and personal development. Clare’s is a graduate student and self-taught DIY investor who loves dividend growth. Feel free to subscribe to her blog here or catch up with her on Twitter for more information.
[Important caveat: this involves picking individual stocks! But hopefully by the end of my little explanation you might see that picking individual stocks doesn't have to involve things like market timing, trading, options, borrowing money or any of those other crazy moves we so often hear are the cause of people losing hard-earned dollars. Of course, no investment method is ever without any risk, so please take what I have to say as a suggestion only and always do more research of your own.]
So, you paid off your debts and you’re ready to get started in investing? Or maybe you want to get into the market while you’re still paying off debt, but you don’t know where to start? Maybe you’re even still in highschool and want to put part of your paycheck into something that will eventually give you a greater return than a savings account will.
I think there are two simple ways to get started in investing for beginners. One way is through index funds. The other simple way is through the DRIP plan of a company (or more) of your own choosing (DRIP stands for dividend reinvestment plan). I’m going to talk about the second option, because we hear less about it in the personal finance blog space (I’m assuming because it might seem riskier since it involves individual stocks). Index funds are popular because of their low fees and the fact that you’re not choosing stocks. But index funds still involve choice. You have to choose which index, and even which provider you go with. Some index funds are even “managed” more than others. With DRIPs, on the contrary, you only really have one choice to make – the company itself you invest in. And many have absolutely no fees to deal with at all.
I’m not advocating that DRIPs should be the only part of anyone’s portfolio. I’m not even giving guidelines here on how many DRIPs would make for good diversification. I just want to suggest that DRIPs are a good way to get started in stock investing.
What are DRIPs, exactly?
DRIPs are dividend reinvestment plans administered through individual companies themselves. Pepsi has a DRIP. Walt Disney has a DRIP. Home Depot has one, too. Normally when you buy a stock, you buy it through a broker. The stock is “yours,” but it’s still basically held under the broker’s name. The broker pays you the dividends.
But the companies themselves sometimes sell their own stock (not all companies do this – you need to check). So to invest in a DRIP, sometimes you only need to go to the company’s website, find their guidelines on how to enrol, and then send them a check. Sometimes it really is that simple. No fees. No commissions.
Why Should I Be Interested in DRIPs?
There are many benefits to DRIP investing. In addition to there being no fees whatsoever on many DRIP plans (not on all of them, though – you need to check), dividends are automatically reinvested back into more shares of the same stock – also for no fee (on some plans). This is done at a fractional level – so even if you don’t make enough in dividends to buy a whole share of the stock, you will be able to purchase 0.3251 shares of that stock. All your money goes to work for you.
Most brokers do what they call “dividend reinvestment,” but this is not usually the same thing at all. Most won’t reinvest fractional amounts. And whenever you want to buy more of the stock, you’ll still have to pay commission fees.
One of the biggest reasons, of course, is that you can buy more shares of the stock for as little as $25 at a time, if you like. Don’t have much spare money? Or just don’t want to put too much towards it yet? No problem. DRIPs are perfect for starting small.
Also, there is something about DRIP investing that is just simple to understand in its tangibility. You are the personal owner of Coca-Cola stock, for example. You might own the actual paper certificate which says your name on it and the number of shares you have. It’s an easy way to train and motivate yourself for future savings. DRIPs are also popular as gifts to children and grandchildren. It’s easy to call the company’s agent and request a certificate as a gift.
In my opinion — and I’ve been a DRIP investor for almost 10 years now — I think that DRIPs provide the best way to boostrap yourself into the investing world and toward financial freedom. If you stick with DRIPs that have no fees involved whatsoever, these plans will truly give you the best leverage (in the non-technical sense!) on your money.
How Do I Choose a Company? Isn’t it Risky?
As for risk, think about it this way. You will not be putting your whole portfolio into one stock. You can still diversify between stocks, sectors, and you can combine this strategy with mutual funds and ETFs (I do). In fact, it would be wise to incorporate a single-stock strategy alongside any fund strategy, in my opinion. When the market tanks across the board, it will bring your index fund down all the way with it. Yet if you owned certain pharmaceutical stocks over the last year, you would have seen they didn’t sink nearly as much as the rest of the market. I think both strategies could work well together.
As for choosing a company – there are literally hundreds which offer DRIPs in some form or another, but keep these points in mind:
- only companies which pay dividends will be able to offer DRIPs
- not all companies that do pay dividends will offer DRIPs
- of the ones that have DRIPs, some of them charge fees (these aren’t the ones I would choose)
Many DRIP plans are run by companies you know and love. In order to pay a dividend, a company usually has to be at a certain stage of maturity. Many DRIP companies have been paying dividends for decades uninterrupted. You should pick a company you understand – something like Kraft Foods, perhaps – or Johnson and Johnson. You get the point.
Think about a favorite brand name you like, then find out what company produces it. Go to their website and look for a tab called “Investor Relations.” That’s where you’ll find out if they have a DRIP plan and what its details are. You can then request a brochure or just download it yourself if they provide a PDF (which many do now).
So those are the basics. There’s a bit more to know, but just details. This is the general bird’s-eye view.
For a more detailed account of how to actually enrol in a DRIP, see my guide to commission-free investing.