Using DRIPs and Dollar-Cost Averaging to Manage Volatility

 |  Includes: ABT, AVP, CLX, HAS, JNJ
by: David Fish

With DRIPs, you don’t need much money to start investing. You can begin with next to nothing and end up with a bundle. DRIPs make it possible to invest as little as $25 or $50—and get shares directly from the company without having to open a brokerage account and pay brokers’ fees or commissions.

Why don’t many people know about direct investment plans (also called dividend reinvestment plans or direct stock purchase plans)? No one advertises them. Brokers have no reason to do so and SEC rules forbid companies from advertising them.

Any investment can be risky. But people are more likely to get burned trying to guess which way the market will go. You won’t. Years from now, your conservative investing strategy means that you will have sizable holdings that you built up with money you might otherwise have spent on something you didn’t really need.

The bottom line: DRIPs give you access to the same risk-reducing strategies that big investors can afford—you buy shares on market dips and own lots of different companies. What’s more, as a DRIP investor, you’re less likely to react emotionally to the financial news and you won’t have to worry about your broker. You will just keep adding to the shares you own (in your own name) until you have built wealth.

Advantages of investing directly

  • Risk reduction. The collapses of Bear Stearns and Lehman Brothers (OTC:LEHMQ) are stark reminders that broker risk does exist. With a DRIP, the stock is registered in your name--not in the name of a broker who holds your account. What’s more, you can probably afford to own lots of different companies if you invest through DRIPs – such as Abbott Labs (NYSE:ABT), Avon (NYSE:AVP), Clorox (NYSE:CLX), Hasbro (NASDAQ:HAS), Johnson & Johnson (NYSE:JNJ), and many more blue chip corporations. This diversification also reduces your risk.
  • Dollar cost averaging. You can invest as little as $25 in each company whenever you have the money to do so (of course, you can also invest a great deal more than that). Or you can set up a program to invest automatically on a regular basis. This systematic approach is known as dollar cost averaging . Doing so through a DRIP means you don’t have to guess which way the market is going next week, next month, or next year. You are in for the long haul. Market slumps can actually be an advantage. When the market is down, your investment will buy more shares than it would when the market is high.
  • Diversification. Because you can open a DRIP account with a single share of stock (or as many shares as you would like) you can become an owner of lots of different companies. There are companies that offer DRIPs in virtually every industry. You can use the search function here to find companies based on industry to create your diversified portfolio.
  • Efficiency. Unlike traditional investing, which is based on buying certain numbers of shares, DRIP investing is based on dollar amounts. A no-fee DRIP makes it feasible to invest even small amounts on a regular basis. Dollar-cost averaging also imposes discipline on your investing because you decide how many dollars you intend to invest on a schedule that you set up in advance. By investing a fixed number of dollars on a regular basis regardless of the share price, you end up buying more shares when prices are low and fewer shares when they are high, the classic goal of savvy investors.

Disclosure: Author owns ABT, AVP, and JNJ.