January’s financial dumpster fire torched nearly every portfolio on the planet. Easy to say, “buy the dip” but harder to do effectively. Most portfolios underperform the stock market at large because investors sell low, only to buy higher later!
Except for DRIP investors, that is. They scale up their stock purchases during pullbacks, and scale down their buying during run-ups. That’s how wealthy people invest… they buy more when prices are low.
If you’re not familiar with a DRIP, I’ll explain what they are, and show you how to set one up in a minute. And if you know DRIPs, I’ll show you a new technique you can use to maximize your performance.
In summary, you can beat the stock market regularly – and buy every dip – by following two systematic steps.
Step 1: Invest in Dividend Payers & Growers
Studies by two global investment heavyweights, BlackRock and GMO, have shown that 90% of U.S. equity returns over the past 100 years have been thanks to dividends and dividend growth.
Ned Davis Research also conducted its own 43-year study on stock returns (from January 1972 through December 2014). The conclusion? You’re only going to make money if you buy stocks that pay dividends:
Most recently from 2000-2012, dividend-paying stocks outperformed the broader S&P 500 more than four-fold during a period that included two nasty bear markets. The dividend payers returned a respectable 7.7% annually versus just 1.7% for the S&P 500:
It’s obvious what you need to do to make money in stocks: You need to buy stocks that pay dividends.
And Step 2: Use Your Dividends to “Time the Market”
Then, you need to make your money work for you. Again, that’s what wealthy people do. Take your payouts and get them compounding.
A Dividend Reinvestment Plan (DRIP) lets you reinvest your cash dividends and purchase additional shares (or even fractional shares). So that, next quarter, your dividend is larger – and you get to buy more new shares than last quarter – and your wealth builds on itself.
There are two aspects of DRIPs that make them particularly attractive. First, you don’t pay any commission on the additional purchase – which means your cash dividend buys its full weight in shares.
Second, thanks to the periodic nature of the reinvestment, you get more shares when the stock price is lower, and less when it’s higher. This simple system is a great “human-proof” market timing technique that guarantees you won’t talk yourself out of buying low when fear is likely to be most widespread.
This compounding really adds up over time. On Monday, we discussed three dividend stocks that you should buy and hold forever. In line with the research we discussed earlier, the returns of Johnson & Johnson (JNJ) and Wells Fargo (WFC) with dividends reinvested have doubled up what investors saw from stock price appreciation alone.
JNJ 10-Year Return (With Dividends Reinvested vs Without)
WFC 10-Year Return (With Dividends Reinvested vs Without)
Bonus Step: DRIP Your Best Buys
Traditionally, you’d set up a DRIP directly through the company itself (like JNJ). That’s how you’d get around paying commissions. You buy the shares direct, and they reinvest your dividends instead of cutting you a check. No middleman.
But now many brokers will let you enroll in the DRIP programs of stocks you already own. You just need to call or email them to request this.
When I contacted my online broker (Scottrade) to setup a DRIP, they actually went one better. The company now offers a reinvestment program that lets you choose which stocks you want to reinvest your dividend cash into, commission-free.
This means I don’t have to buy shares in the same company that paid me the dividend. I can reinvest that capital into any stock in my portfolio. So I plow my payouts back into the stocks in my portfolio that are best buys. I’m purchasing low, in an accelerated manner.
Should You DRIP?
Unless your dividends are paying your living expenses, there’s no reason not to call your broker about setting up a DRIP. As long as there are no fees and commissions – and there shouldn’t be – it’s the best way to compound your portfolio’s growth. And if they offer any sort of flexible reinvestment program, take it.
My favorite stocks to DRIP today pay yields of 6.5%, 7.5%, and 8.2%. These are sizable dividends that’ll get your portfolio rolling immediately. And they’re the perfect stocks to buy, hold, and DRIP for years as you build your very own “No Withdrawal” portfolio.