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Wednesday, July 27, 2011
"I'm a college student. I want to start investing. I have $350 to start with. And I want to add $50 a month to my portfolio. What should I do?"
I get this question – or a variation of it – from a Palm Beach Letter subscriber almost every week.
The stock market is not friendly to investors with small amounts of capital. It's the fees. The cheapest brokers charge around $10 to place a trade. So if you're placing trades with less than $500, you're losing at least 2% of your money every time you buy or sell.
In today's essay, I'll show you how to invest in the stock market without paying any broker fees or commissions. The low entry price of this strategy opens up the stock market to college students, children, beginners, and anyone else who has less than $500 to invest.
The wealthy can use this technique, too. It'll save hundreds of dollars in commissions each year. But more importantly, I know of no better way to compound wealth and generate income than this strategy.
Most people don't know this, but many companies sell their stock direct to investors. Instead of buying stock through a broker – as you normally would – you contact the investor relations department of the company you want to invest in.
You tell investor relations how much stock you want to buy. Then you write them a check. They send you the stock or, if you prefer, they keep it for you in a segregated account under your name. It's that simple. And you often don't pay a dime in fees.
Buying stock this way is like going to the Nike Factory Outlet to buy your sneakers instead of going to Foot Locker. You avoid paying a mark-up to the retailer – or, in this case, the stockbroker.
Financial planners call this strategy "direct investing," or DRIP investing. DRIP stands for "dividend reinvestment plan."
DRIPs have benefits besides no fees. They let you buy fractions of shares, in increments as small as $10. So you can set up a regular purchase plan that allows you to buy a little bit of stock on a set schedule.
For example, Johnson & Johnson's stock trades at $66 per share. But that doesn't stop you setting up a plan to invest $25 per month in Johnson & Johnson's DRIP.
DRIPs can also reinvest your dividends automatically, and some of them let you put their stock in your IRA, which means you don't have to pay tax on dividend income. (Some companies even offer discounts to the market price of the stock.)
Not all companies offer DRIPs. But all the highest-quality dividend-paying stocks have them, including almost all blue-chip and large-cap stocks.
For me, this is what makes this strategy so appealing. Not only is it an extremely efficient way of investing, but you'll buy stock in companies like Proctor & Gamble, Coca-Cola, Altria, 3M, and Conoco Phillips. These companies are among the strongest, most recession-resistant companies in the world, and they raise their dividends every year.
So with DRIPs, you can eliminate fees, invest money regularly, reinvest dividends, and put your money in the safest, most shareholder-friendly stocks in the market. Given enough time, it's the perfect recipe for compounding even a small amount of money into a fortune.
Take 3M for example. 3M, the maker of Scotch Tape and Post-It notes, is the star of the consumer-products industry. 3M is one of the strongest, safest, most profitable companies in the world.
Right now, 3M pays a 2.5% dividend. It has raised its dividend every year for the past 52 years. 3M's perpetually rising dividend makes it one of the greatest money-compounding vehicles of all time.
And through its DRIP, 3M will sell its stock to you with no fees, no matter where you live in the world, in amounts as little as $10 per transaction.
So let's assume our reader invested her $350 into 3M on January 1, 2011 using 3M's DRIP. She also signed up for automatic investments of $50 per month. We'll assume 3M continues to raise its dividend at the same rate it has raised it over the previous 10 years – 6.2% per year.
On January 1, 2030, our reader will have a position in 3M stock worth $22,009. And that's assuming 3M's stock doesn't appreciate in value at all over the next 20 years. The gains come entirely from investing a little bit every month... and reinvesting the growing dividend. It's an incredible path to wealth.
The best website for researching DRIPs is www.directinvesting.com. It has a free search box where you enter a ticker symbol. If the company offers a DRIP, it shows you the details of the plan.
If you don't have much capital to invest with – or you love the idea of compounding the wealth you already have – get started with direct investing.
Learn more about the power of compounding here...
THE "MUST WATCH" NUMBER FOR STOCKS
The big number for the stock market right now is 1,363.
For the past six months or so, the benchmark S&P 500 index has drifted in a "no man's land" between the mid-1,200s and the mid-1,300s. The highest close the market managed during this time was 1,363.61 on April 29. The market has made several attempts to best this high... only to be met with waves of selling.
Despite these waves of selling, the market still sports a bullish "higher highs and higher lows" uptrend. And despite all the worries about the debt ceiling crisis, the market has climbed into the 1,340 area... just a chip shot from breaking out to a new 52-week high.
In The Daily Crux