Dividend Reinvestment by Larry Potter

Our readers know that we have little faith in the "buy and hold" approach to stock-buying. Wall Street, on the other hand, wants investors to "stay the course" and stick with their stock positions through thick and thin.

We would rather avoid the sleepless nights of the thin times like 2000-01 and the summer of 2004 when portfolio values plunged. That’s why we concentrate on short-term investing, grabbing sizeable profits when the trend is with us and heading to the sidelines when the trend changes direction. However, some trades are so successful that they last for many months.

Another exception is a stock with an emotional attachment for the investor. Maybe they were the first few shares you owned; or you got them from your grandfather in the will; or you worked for the company for a few months right out of college. It’s understandable. W’d feel better about that stock, though, if it pays a dividend.

One more exception is a slow-moving, very low-risk stock that also pays a dividend.

In situations like the above the key is to maximize your return by reinvesting dividends in the company’s stock. Warren Buffet and other famous investors have long advised the use of dividend reinvestment. It is often compared with compound interest as dividends compound your gains over time.

Certainly, hanging onto your shares exposes you to the ups and downs of the market. But the yield will boost your overall return and cushion your position in the bad times.

It’s important to own shares of solid companies that will come through bear market cycles with the least amount of damage. Some of the high-flying companies of today that boast a massive dividend will undoubtedly drastically reduce or eliminate the payout during the next downward leg of the current bear market. Look for firms that steadily increase their dividends–even during the tough times. Use the payout to buy more shares of the same stock.

That leads us to Dividend Reinvestment Plans, or DRIPs. Many dividend-paying companies allow shareholders to buy one or more shares of their stock directly from the company instead from a broker. You can then add multiple, individual or even fractional shares of the same stock to your plan, and you can direct the company to take the dividends and buy even more shares for your plan. Some companies will offer these shares at a discount to the market price.

Along with possible discounts for shares, a DRIP allows the investor to accumulate shares without paying a broker’s commission. It is also a favorite strategy for investors who like "dollar cost averaging" in which they balance their portfolio returns by adding an equal amount of funds every week, month, pay period, etc.

More than 1000 companies offer DRIPs. Some of them are sound DOW companies and some are volatile newcomers or high flyers that are best avoided. You can find out more about them at one of the many web sites devoted to DRIPs.

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