Dividend Reinvestment Plans: Value Investing With a Dividend Boost
by Wayne A. Thorp
Many investors today focus on the price performance of their holdings, forgetting one of the basic principles of investing: Total return consists of price appreciation and dividends received. Conversely, many value investors often rely on dividends to stabilize their returns, especially during periods of market instability.
A conservative, low-cost approach to investing in dividend-paying stocks is with dividend reinvestment plans (DRPs), particularly those that sell initial shares directly to the public (direct purchase plans) instead of having to go through a broker. With these plans, dividend payments immediately go to work for you with little or no transaction costs. [Our annual guide to direct purchase plans starts on page 15 of this issue.]
While there are distinct benefits to DRP investing, one potential pitfall to investing exclusively in companies with dividend reinvestment plans is that you may end up with a portfolio that is overweighted in particular sectors of the market. This is because companies that offer DRPs tend to be concentrated in specific industries, such as banking and insurance. Concentrating your portfolio in a limited number of sectors or industries can lead to a non-diversified portfolio without a rate of return that compensates you for the higher risk.
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