How Small Investors Build Big Portfolios One Step at a Time

Brad Briggs's picture

Thursday, September 10, 2009 - 5:12pm

by Brad Briggs

Wall Street loves to make things hard.

People are mystified by the black arts practiced in the world's financial capitals. These sorcerers hold a secret that everyone from a lowly financial adviser to a big-time deal maker doesn't want you to know . . .

The secret: It's not hard to build wealth. It's not even remotely difficult.

In fact, you don't even need a broker -- or even a brokerage account. If you learn to master a simple but extraordinarily powerful tool, you can build substantial wealth. Thousands of people of modest means have used this tool to build million-dollar portfolios.

This tool can send your kids to college.

It can fund an early retirement.

It can buy that beach house or that dream car. And best of all, you don't have to be a big-time Wall Street player to do it.

In fact, you can invest as little as $25 a month and still be able to harness the power of this strategy. Now, as with any tool, you have to learn how to use it and be willing to exercise the patience to master it. But the thing that makes this tool so powerful, so compelling, isn't timing the market or investing skill or any other trick.

It's time.

If you combine a long-term investing period with this easy-to-use inexpensive tool, then you will begin taking the single easiest steps I know to build wealth.

The strategy is buying direct, typically through something called a Dividend Reinvestment Plan, or "DRIP."

A DRIP is a type of account that offers individual investors the opportunity to buy shares directly from a company rather than from a broker. These shares are bought in one of two ways.

The first way is by direct purchase. This is when the account holder puts money in the account to buy shares of the public company that offers the plan. Most DRIP account holders opt to buy shares at regular intervals, perhaps scheduling automatic withdrawals to coincide with pay dates. These transactions can be for as little as $25. (That might not sound like much, but everyone has to start somewhere, and even little amounts sure add up over time.)

The other way DRIP investors buy shares is through dividend reinvestment. DRIP account holders can reinvest their dividends in additional shares.

Say Company XYZ offers a DRIP. An account holder has 100 shares. The company declares a $2 dividend, which entitles the account holder to a $200 payment. (100 shares times $2 per share in dividends.) On the day the dividend payment is made, Company XYZ's shares are trading at $40 each. Instead of receiving a dividend check, the DRIP investor would have five more shares credited to his account -- worth the $200 -- bringing the total of shares held in the account to 105.

The next time the company pays a dividend, the investor receives payment for all 105 shares. This continues on as long as the account is open.

One great part of this plan is that ALL of your dollars are put to work. If the periodic investment or the dividend isn't enough to buy a whole share, then the DRIP sells you a fraction of one.

All of these small-amount transactions would add up over time. Even if you had an account with a discount broker, paying that $7 commission would eat up 28% of a $25 investment. But DRIPs typically charge very small transactions fees. Often, they charge nothing to buy shares, only to sell. Over time, this is a substantial savings.

If I had to give one piece of advice to a young investor, I'd tell them that setting up a DRIP is one of the smartest things they can do. Let me expand that. I'd give the same advice to adults and to seniors. And to children. Budding investors under 18 can use these plans if an adult sets up a "Universal Transfer to Minors" account for them.

Dividends are a very powerful force: They've accounted for about 42% of the S&P 500 Index's total return since 1929. Telecoms and utilities are great for DRIPs because they are generally stable companies that pay solid dividends and typically don't see wild price swings.

How It Works in Real Life
Just to illustrate the power of a good stock and a DRIP, let's say you took $200 and bought shares of AT&T (NYSE: T). The shares cost about $25, so that means you'll own eight shares. Let's also assume you're able to scrap together $200 each month for 30 years to buy more shares.

Let's assume AT&T returns 8% a year. Here's what your investment would be worth with dividends reinvested and without:

If you're a High-Yield Investing subscriber, you've seen a chart like this before. You'd have a little more than $1 million in 30 years after reinvesting dividends in AT&T. (You would miss out on 50% of your potential return if you didn't reinvest dividends!)

There are 684 publicly traded U.S. companies that offer DRIPs. This includes 233 members of the S&P 500 and 28 members of the Dow Jones Industrial Average.

The reason so many stocks have DRIPs and not many people know about them is because Securities and Exchange Commission rules make it difficult for companies to advertise their plans. (High-Yield Investing Editor Carla Pasternak makes a point to mention if a company offers a DRIP plan, so there's no confusion.)

How to Get Started
DRIP investing requires a bit of research at first -- after all, you have to pick which companies to invest in. You'll want to choose a company you understand and are willing to partner with for the long haul. You might start with a company you already own shares in. Some investors might start with a list of companies they admire. Others might look to get the most bang for their book by focusing their DRIP search on companies that pay a high dividend. You have to choose a DRIP as you would choose any other investment: By determining whether or not you are comfortable with it.

As you consider which companies to invest in, keep these resources in mind:

-- Check if a stock offers a DRIP by going to the "Investor Relations" section of the company's website. If you can't find it, call the firm’s shareholder services department. You can also go here to search for DRIPs.

-- Find out who runs the plan. Most of the time it will be a "transfer agent," a back-office that the company hires to keep track of its shares. Several financial institutions act as transfer agents, including BNY Mellon and Computershare.

-- If you already own shares in the company, you can typically have them registered in your own name (rather than your broker's) and then rolled over into a DRIP account.

-- In addition to electing to reinvest dividends, the plans allow additional investments. They go out of their way to make this easy: You can set up an autodraft, transfer money by phone and, of course, buy online after you've registered your checking account with your DRIP. These plans really make it easy to build your nest egg, and there's no reason not to take advantage of these options.

-- Be ready for a piece of mail that talks about taxes. You'll owe a little in taxes on dividends, but it's the lowest tax rate investors pay. Just make sure you include the documentation of these dividends with your next tax return. 

Brad Briggs does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.