Dividend Reinvestment

Let’s start off with some definitions. For the purposes of this article a high yield dividend paying stock is any equity that generates dividends over 3%. This would include certain utilities, master limited partnerships, business development corporations, foreign equities, and domestic stocks. Dollar cost averaging is a strategy whereby a specific amount of money is invested in the same equity or equities on a regular basis over a long period of time. By investing the same amount each time, at specific set intervals, it causes the investor to buy more shares when the price is down and fewer shares when the price is up. It essentially takes the guesswork or speculation out of when to buy. Perhaps of equal importance, a dollar cost averaging discipline causes the investor to make those regular investments whether they are weekly, monthly, or quarterly, which they might not make otherwise. To see specific examples of how dollar cost averaging works, go to any internet search engine and plug in “dollar cost averaging illustrations” and you will see many different scenarios for rising markets as well as falling markets.

Further, to set the ground rules, I am making the assumption that any equity that you would consider for a long term dollar cost averaging program would be one that: you have done your due diligence on, meets your own specific stock selection criteria based on your age, funds available, risk tolerance, etc., and one that you are willing to track to insure that it continues to meet your investment parameters.

Implementing a dollar cost averaging program with a high yielding stock is like operating an automobile with a supercharger. Not only are you buying more shares through your regularly allocated funds, but you have the opportunity to buy even more shares through dividend reinvestment which naturally occurs on a regular interval (normally quarterly) and again takes the guess work out of when to buy and at what price. Like the amount of money that you have allocated for regular periodic investment into the dollar cost averaging program, the dividends will also buy more shares when the price is down and fewer when the price is up.

Oddly enough, while it is a universal mantra to buy low and sell high, it is very typical for investors to do the very opposite. When stocks are down we are very concerned that they will drop further and therefore are hesitant to buy for fear of losing money. On the other hand, when stocks are up we tend to want to get in on the rise before the “train leaves the station” without us. Thus, left to our own psychology and emotions we tend to buy high and either not buy low, or sell low, exactly the opposite of what we should do. A dollar cost averaging program puts investment timing on automatic pilot, and as long as we watch our investments carefully to make sure that the fundamental reasons for including them in our portfolio haven’t changed, then the guesswork, speculation, and worry of when to buy and how many shares, is eliminated. After a rising market, with hindsight, it obviously would have been better financially to invest an entire lump sum at the lower price at the beginning of the investment period. However, without a crystal ball, how many of us have accurately predicted the direction of the market. Conversely, in a falling market a dollar cost averaging program can significantly reduce the average cost versus investing an entire lump sum at a higher price at the beginning of the period. Dividends, fortuitously enhance the dollar cost averaging program both in a rising and falling market.

Finally, if you select a stock that has a consistent history of raising its dividend every year for inclusion in your dollar cost averaging program, that adds even more horse power, but that will be the subject of a future article.

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