Simple Investing, One Dividend at a Time
By Floyd Saunders, The Author of Five Paths To Wealth, Family Financial Freedom and Figuring Out Wall Street.
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The biggest advantage of participating in a DRIP program is that it provides low-cost compounding of your investment dollars, allowing you to accumulate more shares and increase the value of your position at a faster rate-- even when the price of the stock itself doesn't do as well as you might have hoped.
This advantage was clearly spelled out in the book "Triumph of the Optimists: 101 Years of Global Investment Returns," which found that, over the course of the 20th century, a portfolio with dividends reinvested would have generated nearly 85 times the wealth of the same portfolio relying solely on capital gains for growth.
For instance, check out the following two scenarios involving the stock of Johnson & Johnson (NYSE: JNJ).
Let’s assume you are able to start with 100 shares of Johnson & Johnson and that it pays an annual dividend of $2.64 a share, or 66 cents per quarter. In this case, let's assume your 100 shares of JNJ stock was purchased at $85 per share, or $8500. $85 a share for JNJ is about the average share price, it’s range over the past 52 weeks has ranged fro a low of $67.80 and a high of $94.42.
Here's how your JNJ investment could play itself out:
Scenario 1: JNJ Without a DRIP
Over the course of two years, JNJ's stock price could fluctuate but wind up right back where you started, at $85 per share. If so, you would receive $66 per quarter in dividend payments. But without a DRIP you would collect and spend the entire $528 leaving you with no capital gain and a position still worth just $8,500.
Scenario 2: JNJ With a DRIP
However, the results are very different if you decide to enroll in JNJ's dividend reinvestment plan, which allows you to convert each quarterly payment into new shares at the market price, with no commissions and a reinvestment fee of just $1 per transaction. Again, let's assume the stock fluctuates, but winds up right where it started, at $65 per share, after two years.
But, because of the DRIP, the number of shares you hold increases along with the value of your position. By participating in JNJ's DRIP, you've accumulated 10.0297 additional shares, upping your quarterly payout by more than $4 and lifting the total value of your position by $852.52 - even though the stock price ended up exactly unchanged from two years earlier.
Other DRIP advantages include the ability to acquire fractional lots - and even fractional shares - rather than having to wait until you have enough money for a "round lot" (100 shares) or full-share purchase.
In addition, many companies with DRIPs also offer what are known as "direct-stock investment plans" (DSPs). These allow existing shareholders to purchase additional shares directly from the company, in small or large quantities, again without a commission or other fees.