There are many companies that are currently at fair value or are undervalued. Let me explore the idea of buying companies with the synthetic DRIP mentality. Before I do that though, please allow me to discuss how much funds should be accumulated before buying a stake in a company with the cost of commission fees in mind.
How much Funds should I Accumulate before Buying?
With the high cost of living, there isn't much money left every month for investing. Let's arbitrarily say I have $500 left each month. If it costs me $10 per transaction, then it actually costs $10/$500 = 0.02 (i.e. 2% per transaction). That seems a bit too costly. Looking at mutual fund management fees, the expense ratio is the "ongoing expenses of a mutual fund", also called the management expense ratio (MER). They generally range from "0.2% (usually for index funds) to as high as 2%." And those are fees paid every year, which takes away from your total return. Imagine the mutual fund's annual distribution is 3%, you would have already lost as much as 2% return from the distributions for that year, leaving you with 1% return from the distributions. Thus, I think it's reasonable to buy a stake in a company, costing a commission fee of 1% or less each time. For example, if it costs $10 per transaction, then each time you buy a stake in a company, you buy at least $1000.
(Commission Fee / Fee Percentage You're Willing to Pay each time)
The difference is that for buying mutual funds, you're paying the fund managers every year, and that eats away your total return. But by buying a stake in a company, you're only paying this fee once. For the long term, this fee will be negligible, especially if you're building a dividend growth portfolio for retirement. Also note that most likely you will be adding more and more money into the stake (whether for a mutual fund or for a company), and the former will cost more in fees each year.
Following our example, if I have $500 left each month, then, I'll have $1000 each 2 months for investing. Let's compare the cost between buying a stake in mutual fund and a stock assuming a 1% MER for the mutual fund at the end of each year and a 1% commission fee for each transaction of buying a stock.
|Year||Month||Total Month Invested||MER (1%)||Stock Commission|
In the short period of 3 years, we already see astounding results. Buying a stock, dollar-cost averaging bimonthly, costs half as less than buying the same amount in a mutual fund. As time elapses, the mutual fund will only cost more and more as you put more and more money into it.
It follows that any purchase north of that amount ($1000 in this case) is worthwhile, especially if you're holding for the long term. So every time I save up to $1000 (whether it'd be from paycheck or dividends), I can add to positions of wonderful companies I already own, depending on which one looks the most compelling at that point in time. If nothing looks compelling enough to buy, I simply save up more so that my next purchase can be even cheaper than the 1% fee OR I could add to 2 wonderful companies. Added together, these increments of purchases over long periods of time will create the dollar-cost averaging effect, averaging the cost of my holdings, while paying me a growing dividend every year (given that I've done my research on which wonderful companies to own). If you're able to buy on significant dips, you're able to start off with a higher yield for your dividend growth.
Own Companies with the Synthetic DRIP Mentality
I understand that some investors have access to full DRIP (Dividend Reinvestment Plan) so that they're able to reinvest dividends in partial shares. However, I wondered why certain banks only allow synthetic DRIP, so that reinvestment only occurs if you have a big enough stake in a company for the dividend to buy a full share. That led me to the idea of owning companies with the synthetic DRIP mentality.
Think for a moment that you can only synthetic DRIP. The reinvestment helps your investment grow even faster than full DRIP (assuming you need to invest more money for the synthetic DRIP to put it to work). It forces you to invest more because you want to be able to reinvest automatically.
Further, because more money is invested, investors will think long and hard before they invest in a company.
For example, if I want to synthetic DRIP McDonald's (NYSE:MCD), and I want to reinvest at $90 or less, with the current price of $88.48, I'll need 117 shares to begin the synthetic DRIP.
# shares needed for 1st synthetic DRIP = price I want to DRIP initially / each dividend
number of shares = $90 / $0.77 = 116.88 ~ 117 shares
So, the goal is to accumulate 117 shares overtime (as I have limited funds). With the current price, that is a total of $10,352.16! If one is uncomfortable in owning that many shares of McDonald's, maybe one should rethink about whether they really want a stake in the fast-food restaurant chain.
If you don't think $10,000 is a lot of money, the synthetic DRIP mentality is easily scalable. Think about synthetic DRIPing for 2 full shares or 3, or 4,... at which the formula above changes to
# shares to buy 2 shares on synthetic DRIP = price I want to DRIP initially * 2 / each dividend
# shares = $90 * 2 / $0.77 = 233.76 ~ 234 shares
Maybe you disagree with buying enough stake in a company with the mentality for synthetic DRIP, but thinking this way helps put you in the position of choosing the best of the best companies, to invest our limited funds in the best ideas.
Of course, you could also receive the dividends, and accumulate funds to buy a company of your choice; however, remember that each time you buy this way, there's a fee involved. Even if that commission fee is negligible for the long-term investment, you're still throwing that money away, unless you buy at a significant drop (that equal multiple quarters of dividends like the current Intel (NASDAQ:INTC) if you had bought it several months ago versus now).
- Accumulate enough funds (to make the commission fee worthwhile) before buying a stock
- Think with the synthetic DRIP mentality before investing in a company, as
- it forces you to think long and hard before investing in a company
- it forces you to buy stakes in your best ideas
Disclosure: I am long MCD, INTC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.