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Think you don't have enough extra cash to make investing in the market worthwhile? Not so, if you have time on your side.
Say you start with nothing and invest $100 in the market every month. If you achieve the market's 11% long-term average annual return; your account would be worth $21,900 after 10 years, more than $87,000 after 20 years and $280,000 in 30 years.
The challenge is finding ways to invest small amounts efficiently. Even a relatively low $15 brokerage commission takes too big a bite out of a $100 purchase.
Traditionally, direct investing was the best way around that problem. Direct investing means buying shares or reinvesting dividends by dealing directly with the issuing corporation instead of going through a stockbroker. Direct investing usually implies buying dividend-paying stocks.
That makes sense because considerable evidence -- most recently Jeremy Siegel's new best-selling book, "The Future for Investors" -- shows that long-term investing in dividend-paying stocks outperforms other investing strategies.
2 ways to buy direct
There are two types of direct-investing plans: direct stock-purchase plans (DSPs) and dividend-reinvestment plans (DRIPs).DSPs allow you to purchase shares directly from the issuing company instead of going through a broker. You can make a single purchase or set up a periodic purchase plan. According to DRIP Central, a free site focusing on direct investing, more than 540 companies offer this service. You can see a partial list here.
DRIPs are dividend-reinvestment plans run by corporations for investors who already own at least one share of the company's stock. DRIPs let participating shareholders collect their dividends in the form of additional shares instead of cash. For instance, assume that you own one share of a stock trading at $100 per share. If the company paid a $3-per-share dividend, your dividend would equate to 0.03 shares of stock; after the dividend, you would hold 1.03 shares.
That may not sound like much until you look at some real numbers.
Say you owned shares worth $1,000 of a company paying dividends equating to a 3% yield (your yield is annual dividends divided by the share price you paid for the stock). To simplify the example, assume that you don't buy any more shares and the stock price doesn't change for a year. After the year, you'd have $1,030 worth of stock that would now be earning dividends. Assuming the same conditions, after two years, you'd have $1,061 that would earn the 3% yield in the following year. So by reinvesting, your dividends earn dividends.
Once you're enrolled, many DRIP plans allow purchase of additional shares without paying a commission. Most companies do not charge for the service.
The Moneypaper, a subscription newsletter focusing on DRIP investing strategies, and DRIP Wizard, a company that sells a software package for tracking DRIP investments, provide free access to databases of companies offering DRIPs.
Better ways
There's a downside to direct investing. Unforeseen bad news can strike just about any stock. That's why it's important to diversify. But with DSPs and DRIPs, you have to join a separate plan for each stock that you want to buy. You'd have to join five different DRIPs if you wanted to reinvest dividends from five different stocks.You can get around that problem by purchasing through stockbrokers set up specifically to handle small, periodic investments, instead of buying directly from the issuing companies.
ShareBuilder and BuyandHold, a division of Freedom Investments, are two such brokers. Their fees are considerably lower than traditional discount brokers for this type of investing.
Also, most online brokers offer free dividend-reinvestment plans. So, if you're investing larger sums, say $2,000 or more in each stock, you can probably implement a dividend-reinvestment strategy using your regular broker.
Picking dividend stocks
With dividend-paying stocks, you'll get the best returns from stocks that increase their dividends while you hold them. When that happens, you win two ways. Your dividend yield increases with the higher payouts, and the dividend increase often drives the share price higher.When it comes to dividend growth, history is often your best teacher. Stocks with a consistent history of dividend growth are likely to continue that pattern. Fortunately, you don't have to spend days or weeks finding the best candidates. Mergent and Dow Jones have already done the heavy lifting.
Mergent, formerly a division of Moody's Investors Service, each year compiles a list of stocks that have increased their regular annual dividends every year for at least the last 10 years. Here's a link to this year's list of 314 stocks meeting that requirement.
The Dow Jones Dividend Index includes 100 of the highest-yielding stocks in the Dow Jones U.S. Total Market Index. Qualifying stocks must have grown dividends over the past five years, and their payout ratio (percentage of net income used to pay dividends) must be no higher than 60% over the past five years. Also, on average, at least 1.5 million shares should trade daily. Dow Jones excludes real estate investment trusts (REITs) because it considers them to be less predictable than regular stocks. Here's a link. To see the list, select the most-recent market date and select "Get Report."
Stocks on these lists do not necessarily offer direct purchase or dividend-reinvestment plans. You can find out if a company does offer these plans by checking the investor relations section of its Web site. Of course, that won't matter if you intend to buy shares through a regular broker or via ShareBuilder or BuyandHold.
ETFs offer diversification
Exchange-traded-funds (ETFs) are similar to mutual funds except they trade like stocks. Several recently introduced ETFs specialize in dividend-paying stocks. Because they hold at least 50 stocks, dividend-paying ETFs offer better diversification, and thus are a safer way to invest than buying individual stocks.Currently available dividend-paying ETFs include:
Generally, ETFs don't offer direct purchase plans, so you'll have to buy them through a broker. You pay the same commissions for buying or selling ETFs as you would for trading stocks.
Dividend ETFs are new on the scene and, as of this writing, ShareBuilder offers only the PowerShares HighYield Dividend Achievers and iShares Dow Jones Select Dividend Index funds, and BuyandHold doesn't support any. However, this situation is likely to improve as time goes on.
The key to successful long-term investing is staying the course. It's tempting to skip a monthly investment when the market is down, the market is up or you need the cash for a ski trip. If you don't have the necessary discipline, ShareBuilder and BuyandHold offer plans that automatically withdraw a fixed amount from your bank account each month.
At the time of publication, Harry Domash did not own or control shares of the equities mentioned in this column.
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