Frequently I
am asked questions regarding how a couple should invest money for their children’s
future.
From my
experience, the best option is to use a Dividend Reinvestment Program or DRIP.
A DRIP is a
stock-based investing plan that is issued by most major corporations that pay a
dividend.
A dividend is simply excess cash returned to shareholders. Historically, dividends have
accounted for most of a stock's growth.
To start a
DRIP investment plan you will need to invest an initial amount of money, say
$100, in the account and then your account will automatically reinvest
dividends each time they are paid.
For example,
the $100 of cash used to purchase shares in a dividend paying stock may allot
you one share of stock. Additionally, the stock has an anticipated yearly dividend
of $2.00. Typically, dividends are paid quarterly or four times a year. Every
time a dividend is paid the money is used to purchase new shares at the current
market price.
So, if the
stock you purchased went from $100 to $110 dollars during the first quarter of
ownership and pays out an annual dividend of $2.00, you would see $0.50 per
share reinvested in the stock at a $110 price for that quarter.
As a result,
the number of shares you own will increase with every dividend reinvested. Therefore,
you are growing your account effortlessly!
This compounding of shares is the real benefit of DRIP investing. That is, your ownership stake
increases with every future payout with dividends being paid on a per share
basis.
To use the
example above, at the end of the first year you will no longer own only one
share but the initial share plus the four dividend reinvestments represented as
fractional shares. Thus, your dividend will be calculated and paid on a larger per
share basis including the initial shares plus the reinvested shares every
quarter.
While the
initial growth will be small, you can see how over time the DRIP will allow for
your account to grow through the magic of compounding. In other words, you just
sit back and collect your dividend payments while your money works for you.
“Good investing is
boring” – George Soros
For example,
if you had bought The Hershey Company in 1984 and 1986 with no other purchases,
you would have around $20,000 in dividends reinvested over that time. No to
mention, your account would show a gain of over 3,500% and 1,500% on those
original purchases, respectively.
Additionally, the quarterly dividend payments
received in present day would far exceed the initial money used to buy the
original shares. Now that’s a return on investment!
Other good
investment options for a DRIP include companies that have a global brand to
support a healthy dividend payout. For example, 3M, Johnson & Johnson,
Proctor & Gamble, Colgate Palmolive, or Clorox are excellent DRIP
investments.
Also,
having a history of not just paying a dividend but growing the annual dividend
is important as well. When a company increases its annual dividend every year this
means that your income from the investment will grow automatically!
Another
benefit to a DRIP is its flexibility. First, you can contribute more to a plan
whenever you want. Second, you are not limited to the number of DRIP’s you own
which can improve your investment portfolio’s diversification. Third, a DRIP
will reinvest your dividend without having to pay commissions so your total
dividend is able to be invested and compounded. Finally, a DRIP is a taxable
account which means that you can withdraw the money at any time without
penalty.
Conversely,
since a DRIP is taxable you will have to pay taxes on your annual dividends as
well as any capital gains realized during the year. However, if you do not sell
any shares then there will be no capital gains taxes. In most cases only the
dividends will be taxed which is a modest 15% yearly tax.
If you are
interested in using a DRIP, you can contact the investor relations group
representing your stock of choice. These individuals will be able to help you
with the minimal paperwork required to get started as well as answer any other
questions. Once you own shares you will be introduced to the bank that will
hold your stock, keep accounting records, and administer the account. This bank
will also send you quarterly statements and a yearly 1040 tax form.
The sooner
you start a DRIP investment plan for your children the better their financial
future could be.
As always,
if you have questions or comments, feel free to send me a message. Thanks for
reading.
John
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