If you think buying stocks for their dividends is boring, well, maybe sometimes it is – but certainly not always! The right ones can be surprisingly lucrative, and that’s pretty exciting. And with a little luck, they can generate hefty and growing returns for many years.
One strategy dividend investors might want to consider is buying DRIPs, or Dividend Reinvestment Plans. They are easy to understand and can be set up very easily by simply calling a broker or the issuing company. The idea is to own more shares in the company and enjoy the additional dividends they pay.
Here’s an example of how they work. John and Jane buy shares in XYZ, which pays a cash dividend. At the next payout date, they can take their dividend and use it any way they choose to. Or they can participate in the company’s DRIP and use the cash generated to purchase additional shares.
If they choose to do this, they will own more shares. Then, at the following payout date, they will earn dividends on the original shares they purchased as well as on the new shares they now own.
Don’t expect those additional dividends to amount to big bucks – certainly not initially. However, if John and Jane participate in XYZ’s DRIP each quarter the number of shares they own will increase steadily.
Of course, it is possible to pursue this strategy even with a dividend-paying company that doesn’t offer a DRIP. However, many DRIPs have other benefits, too, such as enabling participants to purchase fractional shares; this makes it possible to put even very small amounts of money to work for shareholders. Moreover, in many DRIPs, shares can be purchased commission-free, and some even allow participants to purchases shares at a discount to the market price – nothing dramatic, but a few percentage points here and there can also add up.
Over the long term, reinvesting dividends has proven to be a very successful strategy on Wall Street. “The primary reason to reinvest your dividends is that doing so allows you to buy more shares and build your wealth over time,” explains Investopedia. “If you examine your returns 10 or 20 years later, reinvesting is more likely to increase the value of your investment than simply taking the cash dividend.”
The Good And The Not As Good
Despite their benefits, investing in DRIPs is not a sure thing. For example, all companies have to deal with challenges, and if some of those are intense enough and prolonged, the company may be forced to slash or even eliminate the dividend entirely; companies absolutely hate to do that because it drives the stock price lower, but in real life it does happen.
Once enthusiastic investors are then left holding depressed shares that no longer pay the dividend that made them appealing in the first place. And there is no way to know when – if ever – the dividend will be restored.
In theory, investing in DRIPs could be very helpful to a wide range of investors – those interested in safety, growth, a way to supplement income, and to help pay for children’s and/or grandchildren’s education or other expenses.
Depending on how much money is invested in a DRIP, the rate of the dividend and at what point in the investor’s life he or she starts purchasing them, the dividends may amount to enough money to help with the mortgage payments or even help pay one off early, saving months or even years of payments.
Some forward-looking parents enroll their very young children in these programs or include them as part of an inheritance, enabling them to accumulate many shares for use as they see fit as they get older. Incidentally, if you still think stocks that pay dividends are boring, please note that many of the stocks Warren Buffett has purchased and continues to buy pay dividends, and he hasn’t done too shabbily with them over the years.
Arguably, years ago it may have been easier to find stocks that could be purchased with a long-term horizon: Put in a dresser drawer and when checked years later discover that the shares are worth a great deal of money.
Even today, there are still some stocks like that, but they’re becoming more difficult to find and can’t be “filed and forgotten.” That’s because the markets, economies, interest rates, trends and the whole world have become very volatile and subject to sudden and dramatic changes; in some cases, those changes could hurt the share price.
Over time, the number of shares DRIP investors own do add up and the dividends they receive become more significant; when it’s possible for shareholders to add to their positions – even a few shares at a time – that’s gravy on the steak and makes their gains even tastier.
Several months ago, Yahoo Finance compiled a list of the most popular DRIP stocks. That list included: Johnson & Johnson, ExxonMobil, Coca Cola, Realty Income, AFLAC, 3M, Emerson Electric, and Pepsi.
Some investors prefer buying DRIPs in major companies they are confident will have an ongoing business, like McDonald’s and Walmart. However, they should be aware that these (and other companies) charge nominal fees for setting up these plans and additional nominal fees each time dividends are reinvested; they also charge a small charge for additional shares purchased.
Other investors prefer to buy no-fee DRIPs in what’s called dividend aristocrats – companies that can boast 25 or more years of increasing dividends. The logic of this is obvious; however, they need to bear in mind that handicapping the past is easy but no guarantee of future results.
Whatever your preference, always speak with an advisor, who can customize investments specifically to suit your needs.
Sources: businessinsider.com; corporatefinanceinstitute.com; investopedia.com; simplysafedividends.com; suredividend.com; yahoofinance.com