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The Best Financial Gift You Can Give Your Children

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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