Market Beat: DRIP a good building tool
“Constant dripping can hollow out a stone” was a quote from the famous Roman philosopher, Titus Lucretius Carus. What he meant was that a steady stream of water, even in a very small amount would have enough erosive force over a long period of time to wear a hole even in the most solid types of rock, like granite for example.
When hiking in our local Sierra Nevada mountains, one can find many places where there’s evidence of water dripping and wearing out solid rock.
Dripping is a technique that can also be used to build a strong investment portfolio. Most companies offer what’s known as DRIP, or dividend reinvestment plans at no cost to investors. DRIP plans can be a very good tool for building a position in a stock or an exchange traded fund over a long period of time.
According to S&P Dow Jones Indices, since 1926 dividends have accounted for about one-third of total equity returns while capital gains have accounted for about two-thirds of total returns. As you can see, dividends are a very important component of total return.
If you don’t need current income and wish to build a position, reinvesting dividends is a form of dollar cost averaging. If the company or fund pays a dividend every quarter, you’ll be getting more shares consistently. If it’s a company that raises its dividend over time, that will work even better and down the road if you wish to take income at retirement age for example, your yield to cost could be quite high.
For example, say you were to buy 100 shares of a stock today, for $50 per share and the stock had a dividend yield of 2.1% and increased their dividend payout by 5% per year. The $5,000 that you paid for that 100-share position would grow in value to $10,182.14 over 20 years, just by reinvesting the dividends every quarter without the price of the stock increasing at all. Your initial investment would double in value.
The first year, your income would be about $100 and by year twenty the income would increase to over $500 with the payout going up 5% per year.
The current yield on the Diamond, the ETF that represents the Dow Jones Industrial Average is 2.01%. This ETF consists of the 30 stocks that make up the index and can be used for dividend reinvestment.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.