Trading and taxes is your enemy. In previous articles I've written about low or no fee dividend reinvestment strategies that build wealth over time. Today, we'll discuss how these strategies serve to minimize risk, stress, and maximize long-term opportunities while producing acceptable returns.
In examining large cap "blue chip" / well-established companies; you want to look for long-term commitment to dividend, regular quarterly payouts, and at least yearly increases as well as added bonuses such as one time "special dividends," which all serve to return cash to shareholders. As such, these characteristics engender the type of solid shareholder stewardship I like to see in making potential long-term investments.
As a general rule, my minimum acceptable yield is 2.2%. If the equity is a growth company or has steady-increased dividends for at least several years at a good clip, exceptions can be made. Also, a stock's sector should be taken into consideration when contemplating investment. In fact, until relatively recently tech companies were notoriously stingy when it came to paying dividends. More recently however; companies such as Intel (NASDAQ:INTC) and Microsoft (NASDAQ:MSFT) showed a strong dividend commitment, as and sports a 3.5% and 2.8% yield respectively.
Obviously, these factors beg the question; what do investors do with dividends? In brief, investors have one of two choices, collect these monies or strategically reinvest the proceeds into more stock. Arguably, over the long haul reinvesting dividends at regular intervals can be a very smart move, but requires delayed gratification and patience. But, when it comes to solid companies makes an extremely shrewd long-term investment strategy.
Dividend reinvestment is also currently a wise tax mitigation move, since payouts are currently taxed at 15%. However, ongoing federal deficits are likely to reverse this advantage in the future. Still, in my opinion, collecting income passively is the way to go, even for small investors. An added advantage of adopting a passive investment strategy is unrealized capital gains continue to grow tax free and even if sold, long-term capital gains taxes are almost always preferable to short-term rates, so thumbs up in that area as well.
Yet, another advantage to the DRIP approach is low or no fee investing. Obviously, fees add up, just as in the case of mutual funds commissions are the proverbial market "price of admission," but for the long-term investor paying low or zero purchase fees is the way to go and fees on reinvested dividends tend to be very minimal at worst when it comes to these plans. Exxon Mobil (NYSE:XOM) is a perfect example of this. In the company's investment plan, investors pay no fees-zippo. All invested capital is shareholders alone, to invest, reinvest, or collect dividends. Adding to the advantage of direct ownership in my experience is the disincentive to trade actively--out of sight, out of mind, which lets your investment grow-it maximizes returns
But perhaps, the single biggest disadvantage to DRIP investing (if there is one) is determining cost basis. In brief, shares are almost always bought at different times, in different amounts, and even in fractional shares. Therefore, should you decide to sell using a CPA could be an extremely wise move and should be seriously considered.
Obviously, it almost goes without saying that by making purchases periodically either with reinvested dividends or additional capital (or both) yields the advantage of dollar cost averaging (DCA) or buying shares at identical times with exactly the same amount of money for each purchase. This strategy is also frequently used by mutual funds (both taxed and untaxed) and really lies at the heart of the long-term DRIP strategy.
Seeking Alpha Bottom-line
When it comes to investing amidst a high tax / regulated market the tortoise almost always beats the hare. Increasingly, profitable trading is a full-time vocation. In this way, professionals often don't have time to effectively play the market. In my opinion, the central purpose of investing is to have your money working for you, not you work for your money--active traders often lose sight of this. But perhaps they should and take a cue for smaller market stakeholders. In sum, when it comes to today's NYSE, in an increasingly volatile and uncertain market passive investment is arguably the way to go.
Disclosure: I am long XOM. 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.