I flipped on CNBC for a few minutes recently and was instantly flooded with a barrage of flashy ads.
'Trade your way to an early retirement!'
'What kind of a trader are you?'
'Why aren't you trading more?!'
There are brokers and brokerage firms that work very hard to convince investors that becoming the world's greatest trader is as simple as following a few moving averages. But more trading means more fees and commissions for the brokerage firm... in the meantime, it can also lead to more losses for investors.
For that reason, there's one thing your broker may not want you to know about -- in fact, it's one of the best-kept wealth secrets on the Street. Unlike flashy trading systems and technical indicators that require lots of trading and commissions, this system doesn't just eliminate fees. It enables investors to bypass brokerage firms entirely.
The program I am talking about is a Dividend Reinvestment Plan, better known as a DRIP.
DRIPs are investment programs sponsored by publicly traded companies that enable shareholders to immediately reinvest dividends into additional shares of common stock.
Think of it as a platform for companies to have a more direct relationship with shareholders and offer special incentives. And because of that, these little-known programs are incredible long-term wealth builders that offer huge benefits to investors.
DRIPs are a great way for investors to harness the incredible power of dividends. Contrary to popular belief, the numbers prove that dividends are where most of the stock market's gains come from. Researchers have found that more than 60% of U.S. stock returns in the last 140 years have come from dividends.
And that trend has only been accelerating.
From 1988 to July 2013, $10,000 invested in the S&P 500 would have grown to $68,200. But reinvesting dividends would have almost doubled that return, jumping to $120,600.
And with the DRIP using dividends to buy more shares, investors are getting a double dose of compounding returns. That's exactly what my colleague Amy Calistri advocates in her Daily Paycheck newsletter. In fact, she has uncovered a way to obtain 7.2% average yields and 43% safer returns through a system she calls the 'Dividend Trifecta.'
As Amy has found, reinvesting dividends only improves your returns that much more. Here are four reasons why DRIPs are a great way to do that.
Dollar Cost Averaging: DRIPs help investors lower their cost basis by relying on dollar-cost averaging. Over the course of a few years, purchasing more shares as prices fluctuate enables investors to avoid buying big blocks near the high and it lowers their cost basis.
Bypass Your Brokerage Firm: DRIPs also usually enable investors to fully bypass a brokerage firm and buy shares directly through the company program. This is a great way for investors to eliminate cumbersome broker fees and commissions, which can have a big impact on total returns for small investors or orders.
Buy Shares At A Discount: Beyond bypassing cumbersome brokerage fees and commissions, DRIPs also frequently enable participants to purchase shares at a discount. That discount usually falls between 3% and 5% but can stretch as high as 10% in some cases. That is an immediate, no-risk return that is available in few if any other areas of the market. And it's a big chance for DRIP investors to cash in.
Fractional Shares: DRIPs also have the flexibility to cater to a wide range of investors. Most DRIPs enable participants to purchase fractional shares with a minimum investment of just $10. That enables smaller investors just getting started to participate in the program as well. But DRIPs are also backed by deep pockets of liquidity, large enough to absorb larger investors looking to scoop up a few thousand shares.
The Investing Answer: DRIPs are a great tool to cash in on the incredible power of dividends and compounding returns. Opening a DRIP account is simple. It can be done directly through the company or set up through a brokerage account. Participation is highly inclusive, with members usually only required to own as little as one share. DRIPs tend to be offered by larger companies, such as Caterpillar Inc. (NYSE: CAT), Exxon Mobil Corp. (NYSE: XOM) and Yahoo Inc. (Nasdaq: YHOO).