The Easiest Way to Invest in the World's Biggest Companies
Here's a classic way to build up an investment portfolio: Regularly invest modest amounts of money in growing companies. Do that for a few decades, reinvesting the dividends as you go along, and — if you've picked the right companies — you will end up with sizable holdings. Perhaps even real wealth.
If you want a diversified portfolio, and you really should, there are a lot of cheap ways to get one. Any number of mutual funds will let you open an account with a modest initial deposit, and the minimums for subsequent investments are quite reasonable for even a small saver.
But what if you don't like someone else's idea of a diversified portfolio? What if you have some strong opinions about which companies are worth investing in, and out of the thousands of mutual funds available, none of them focuses on those companies? What if you really want to invest in specific companies picked by you?
One option would be to open an account at an online brokerage and make your purchases there. That will work great if you have ample money to invest. But what if your free cash for investing is small?
Even small investments can add up to a lot of money, if you've got both time and a good annual return working for you. If the companies you pick can average an 8% annual return for 40 years, just $20 a week will build to a fortune of over $300,000.
But the online brokerage solution is no good for investments that small, because of commissions. Even the cheap online brokers charge $5 on a trade, and plenty of them charge closer to $10 — there's half your investment gone right there.
Fortunately, there's an alternative that's tailor-made for this situation: Direct Stock Purchase Plans, or DSPPs.
Direct Stock Purchase Plans
Back in my day they were called Dividend Reinvestment Plans, or DRIPs, but they're basically the same thing: Big companies hire somebody — usually the stock transfer agent — to create and manage accounts that let individuals buy small quantities of stock — usually for no commission — and reinvest their dividends.
It's a win for the investor, because they get to invest in the stock for free. It's a win for company, because they get a dependable stream of new capital, and a stable base of shareholders who are aren't likely to sell out at the first sign of bad news or to go chasing after the next hot trend.
Besides charging no commissions, they also solve another problem for the very small investor: the cost of whole shares. Suppose you want to invest $20 out of every paycheck, but the stock you want to buy is $63 a share. It would take you four paychecks to save up enough money to buy one share. With a DSPP you'd get 0.317 shares with the first contribution, and a similar amount each paycheck after.
Things to Know
There are a few caveats.
First, only certain companies go to the trouble and expense of offering a DSPP. Happily, as suggested by the title of this article, they're mostly the largest companies on the U.S. stock exchanges. The web has plenty of lists of companies that offer DSPPs or DRIPs. Alternatively, if you know which company you're interested in, go to the company website and look for a link like "investors" or "shareholder information." If there's a direct investment program, you'll find the information about it there.
Second, buying stocks this way — through numerous small purchases — may make figuring your taxes a lot more complicated in the years that you sell. (This may be less true than it used to be, now that brokers are required to track your cost basis for you.)
Third, be aware that these sort of plans don't offer the services of a broker. They are basically just for accumulating shares in one specific company. They will probably let you shift from reinvesting your dividends to receiving them in cash, something you might want to do when you retire and will be living off your investments. They usually let you take delivery of your stock (if at some point you want to transfer it to a regular broker) or sell it (if you have found a better investment, or need the money to live on). They won't let you borrow against it, they won't have cash management tools, they won't be interested in holding any other shares you own, or selling you bonds, or advising you on other investment opportunities.
Fourth, investing in just one company won't give you a diversified investment portfolio. You'd need a dozen carefully chosen companies to get something reasonably diversified. Of course, as an adjunct to some well-diversified mutual funds, a DSPP in a company that does very well, can provide a considerable boost to your total return, without completely unbalancing your portfolio.
Plans like these used to be a much bigger deal. Especially before 1975 (when minimum commissions were abolished), but continuing right up until Internet brokers got big in the 1990s, the costs to trade stocks were high enough that it was completely impractical for a small investor to gradually accumulate shares in a growing company. Investing in individual stocks was a game only for the wealthy.
It's generally not important these days, but there's a technical difference between DRIPs and DSPPs. Back in the day DRIPs usually required that you purchase your first share from a broker (or acquire it some other way, such as by inheriting it). Then you could reinvest dividends, or even make additional cash purchases of shares, but that first share had to come first.
Starting in the mid-1990s, the SEC relaxed some rules, making it practical for companies to offer DSPPs that could sell you your first share, as well as shares beyond that.
It's kind of a technical point, but that's the difference between the two kinds of plan.
Small Versus Tiny Investors
With internet brokers, even a fairly small investor can buy and sell stocks. You need a certain amount of capital — a few thousand dollars — to make it possible to buy a round lot of 100 shares and to make the $5 or $10 commission a small enough percentage of your total investment.
But if you're a tiny investor — if your investable capital is only a few hundred dollars — something like a DSPP makes it possible for even the smallest investors to accumulate sizable portfolios through frequent, modest investments made over a long period of time.
It's what they were designed for.
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