The Best Retirement Plan No One's Talking About: DRIPs

 |  Includes: PG, XOM
by: Jim Trippon

Over the past few years, retirement has become one of the financial media's favorite talking points. Unfortunately, retirement is normally discussed in a doom and gloom fashion. The pundits scream that stocks have been dead money over the last decade. Stashing cash in CDs, money markets and other cash investments is literally a waste of time if you're looking for any kind of return on investment.

Not to mention traditional pension plans are going by the wayside and the fiscal ineptitude of the political chattering class in Washington, DC has imperiled Social Security. How bad are things on Capitol Hill as they pertain to your retirement? No elected official has the gumption to tackle a soaring national debt and budget deficit and as these numbers grow ever larger, Uncle Sam could be in danger of losing his “AAA” credit rating.

That all sounds pretty foreboding, but I want to tell you not to fret because there is an elixir for your retirement planning woes that is cheap, and in many cases free, to employ, available to investors of all skill levels and involves very little risk. All you need to do to take advantage of a truly great investment opportunity and retirement planning tool is do your high school math teacher proud and remember the concept of compounding interest.

Everyone loves interest that compounds, but the reality is your local bank isn't going to offer any investment options that feature this mathematical miracle. Again, don't fret because the miracle of compounding interest is available to you with very little risk. I'm talking about dividend reinvestment plans, also known as DRIPs.

For all the attention that dividend investing has received over last couple of years, a phenomenon I agree with wholeheartedly, for one reason or another dividend reinvestment still flies under the radar. I find this odd, especially when considering all the cries that buy and hold investing is dead. Saying that buy and hold is dead is a double-edged sword because while the statement is accurate to some degree it is also too broad to apply to every single stock on the market.

Take a look at the chart below of Exxon Mobil's (NYSE:XOM) dividend growth from 1982-2008. After another dividend increase earlier this year, the largest US oil company now pays an annual dividend of $1.76 a share and the dividend growth rate has been a solid 7% a year since 1999.

This is where the fun starts. Let's assume you buy 100 shares today at around $60 and elect to reinvest your dividends and have $200 automatically debited from your checking account every month to buy a few more shares of Exxon. Many companies that offer DRIPs will do this for you free of charge. Let's say for the sake of argument the shares remain flat over the course of the year. That means your $8,400 investment ($60 x 100=$6,000 + 12 x $200 = $8,400) has garnered you around $145 shares before dividends are reinvested. Factor in the dividends and you'll have close to 150 shares at the end of year one.

Think dividend reinvestment doesn't work? Think again. Take a look at a 30-year chart of the S&P 500. The blue line illustrates price appreciation alone. The pink line illustrates your returns using the power of reinvested dividends. That pink line looks pretty good, right?

Let me give you a real-life example of the power of DRIPs. I can remember back in 1996 my dad bought 100 shares of Procter & Gamble at a split adjusted price of about $30. I know he later bought another 50 shares for around $50 in 1999 so his total capital outlay was $5,500. Dad sold his shares in early 2009, so he wasn't getting the best of prices, but that didn't matter. Why? Because even though he bought no more shares of P&G after 1999, his $5,500 grubstake had more than doubled because of stock splits and reinvested dividends.

Imagine doubling your investment over a decade that many call the “lost decade” with a low-risk name like Procter & Gamble (NYSE:PG). Trust me, there is no such thing as a free lunch when you're investing in stocks, but dividends are free money and the power of reinvested dividends is undeniable.

Retirement planning shouldn't be as stressful as the pundits make it out to be. In fact, it can be fun, especially when you're getting statements from your DRIP stocks every year showing your stake growing and growing without you having to do any work. Stick with Global Profits Alert because our dividend analysis is among the best on the Street and I look forward to bringing you more unique dividend winners in the near future.

Disclosure: No positions