Dividend Reinvestment Plans

Brian Hicks

Updated February 9, 2011

As the old fable reminds us, it’s not always the hare who wins the race.

For as savvy dividend investors surely know, it is the tortoise who prospers in the long run.

That’s because the tortoise knows that income investing allows you to win two ways: first, with a cash payout; and second, through price appreciation.

And the best part is you don’t exactly need to be star trader or marker timer to reach your financial goals using this strategy…

You just need to be patient enough to push through the volatility onward to the higher ground.

Of course, seasoned dividend investors themselves have known this for years.

That’s why the truly rich don’t spend their days glued to the financial news like a bunch of lemmings. They realize that while most investors think trading is where the action is, investing in high-yielding income stocks is just as rewarding — provided you are smart enough to stick to a steady and persistent pace.

In this style of investing, less truly is more.

The Rule of 72

Because the biggest component behind this investment strategy is time — time, the greatest equalizer of them all.

The secret to this approach is in the compounding effect that Albert Einstein once called “the most powerful force on earth.”

In fact this force is so powerful that I think the government is deliberately keeping it from you. I say that because if the masses actually knew the income this compounding could deliver, they would immediately demand an end to Social Security as we know it.

Why is that? you ask.

That’s where the Rule of 72 comes in.

The Rule of 72 says that in order to find the number of years it takes for you to double your investment at a given rate, just divide the yield into 72.

For example: If your are earning a 9% dividend on your investment, it only takes eight years to double your money, and roughly 13 years to triple it.

This compounding effect arises when your dividend yield is added to the principal, so that from that moment on, the interest begins to earn interest on itself.

Over time, that process can add up to a small fortune — even with very modest investments.

The Retirement Blueprint

By using this simple but powerful strategy, you can build a $270,000 nest egg in just 35 years by contributing as little as $100/month. That’s basically the cost of a cable bill, and it would yield a 525% gain — a market-beating average of 15% per year.

And it’s easier to come by than you think…

Let’s say you had saved $1,200 and started with an investment in one of my favorite dividend payers, Abbott Laboratories (NYSE: ABT).

That initial investment would buy you 26 shares of ABT at today’s prices, each one earning a dividend yield of 3.8%. Over time, that specific example would earn you a $270,000 payday as long as you simply reinvest your dividends, add a mere $100 a month to your account, and the underlying stock appreciates just 5% per year… Not bad.

Here’s another example as it relates to your Social Security “account.” (This is the part the government is keeping from you)…

Let’s say you invested $10,000 at the age of 30, initially buying just 217 shares of Abbott Labs. If all you did after that was to continue to contribute the same $551 a month you would pay in maximum FICA taxes, a $1,554,634 payday would be yours, according to the exact same formula.

But it gets even better. Because by the time you reach retirement age (65), that same account would be kicking off $54,066 a year in streaming income — all without dipping into your $1.5 million cash cushion!

Meanwhile, if you started the same exact program at age 20, your account would yield a $3,712,910 payday at age 65 to go along with $129,447 in yearly income.

By comparison, starting at age 20 and using roughly the same dollar amounts, your estimated Social Security check would be a measly $51,000 a year for married couples.

That’s it — no cash cushion, no nest egg, and nothing to leave to your children.

Now do you see why Uncle Sam doesn’t want you to know the truth about Social Security?

Because if enough people were aware of the power of compounding, they would immediately demand better — especially those who are just entering the workforce.

And that’s not even factoring in the notion that Social Security will probably go bust at some point in the future…

Dividend Reinvestment Plans

The best part is that big companies like Abbott Labs make this type of investing as easy as tying your shoes.

By using a dividend reinvestment plan, you can practically put a big part of your retirement on autopilot and ignore the ups and downs of the broader markets.

Known commonly as “DRIPs,” these plans give investors the ability to reinvest their dividend payouts immediately back into the company in the form of new shares. This is where the compounding begins.

In addition, most DRIPs permit optional cash investments that participants can send directly to companies to purchase additional shares.

As a result, DRIP investors purchase as many whole and fractional shares as the amount entitles them to, based on the price of the stock on the investment date.

These steady and continual investments in the same company allow DRIP investors to effectively dollar-cost average into these positions, lessening the risk that they will buy them “at the wrong time.”

Instead, these investors arrive at an average price for the security that — more often than not — better reflects the true value of those shares.

The reason for this is simple: Using dollar-cost averaging, more shares are purchased when prices are low and fewer shares are bought when prices are high.

And over time, the average cost per share of the security will actually become smaller and smaller, yielding bigger profits.

The turtles really can win this race…

All it takes to build a nest egg is time, the power of compounding, and a steady, persistent pace.

In Part Two , I’ll go even deeper into DRIPs and explain how to use them to set up the ultimate blueprint for your retirement.

Your bargain-hunting analyst,

steve sig

Steve Christ
Editor, Wealth Daily

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