Is a DRIP or DCAing a better investment strategy?
I have done my research on both a Dividend Reinvestment plan (DRIP) and Dollar Cost Averaging (DCA). Both seem like effective plans and if executed correctly, can produce significant long-term gains. I am fairly young so I am looking for long term and significant gains in my portfolio. Which strategy do you recommend, and what are the pros and cons of each?
Here are the important considerations:
DRIP will keep more of your capital invested without typically incurring additional trading costs. In short:
More saving/investing + long time horizon + lower costs = the odds of success tilt in your favor.
DCA is a good way to spread out the risk of poor market timing. Because you're young, poor market timing is less of a risk for you. For a good example of this, consider the buyer of a lump sum of US stocks on October 18, 1987 (the day before Black Monday). This is arguably some of the worst short-term market timing one could have, but looking back about 30 years later, it is really not much of a factor. Your financial plan hinges on the ability to save and invest, and this continued savings should represent some form of DCA.
Note that you should be careful with DCA in that you want to avoid paying huge transaction costs. As an example, if you invested $100/week, but it costs $5/trade, then you only end up with $95 of investments and you're in the hole 5% to start. A 5% hit is enough to likely offset any potential benefit of DCA. So look to employ a suitable commission free fund or work with a platform that doesn't charge trading fees. As your plan grows and you are doing purchases of $1,000, you can be less concerned with a $5 trading fee as it only represents a 0.5% detraction from performance.
Adam Harding, CFP
I think both are valid strategies and can help you with your long-term objectives. Depending on how much you are contributing in your DCA strategy, you can accumulate a great deal over time. The dividend reinvestment strategy is also beneficial since studies have shown how much dividends contribute to your overall performance over time. Since you are fairly young, stick with both and establish a financial plan so you can monitor your progress over time and make adjustments as your life circumstances change.
DRIP or DCA can both be valid for contributions and adding to or reinvesting the portfolio or corpus. I am less a fan of DRIP or DCA on specific stocks because you are not controlling the timing of that specific stock purchase. If it is a mutual fund, I have less of an issue. But you should add monthly on a systematic plan. The one thing you must understand, though, is this is to add to the portfolio, and not to protect the portfolio. You should also have some type of sell discipline in place for the corpus in my opinion. Now, I am an active manager and do not prescribe to the buy-and-hold through thick and thin in all environments.
For instance, once you have saved and have a portfolio of say, $300K, and are adding $1,000/month, I have no problem with the continued DCA of the $1K, but if we enter into a big correction or even a bear market of -25%, you just lost $75K, and the $1K/month seems insignificant. Now you can't time or predict the tops or the bottoms, no one can, but you can have some intermediate term indicators to help determine when the markets are much more dangerous and avoid those times or hedge. And you will get caught in some of the correction, but if you miss even half, you are much better off and the ride is smoother.
If you are going to do a buy-and-hold strategy, then both DRIP and DCA are valid and an excellent, cost efficient way to execute.
Best of luck, Dan Stewart CFA®
How about both? With a long time horizon, DRIP stocks can indeed provide powerful leveraged returns. And if you're DCAing into your portfolio on a monthly basis, year in and year out, that will compound the effect of the DRIPing.
Both a Dividend Reinvestment Plan (DRIP) and Dollar Cost Averaging (DCA) are effective plans, but they don't have to be mutually exclusive. You can combine the two plans. A DRIP plan effectively uses the power of compounding for additional growth. A DCA plan eliminates the question of market-timing or "is this a good time to buy", which is usually not an effective long-term investment strategy.
If one chooses to invest regularly and consistently as in DCA, I would recommend that one also choose to reinvest the dividends at the same time. 40% of the average annual returns in the stock market over the past 75 years (or more) has come from dividends that were reinvested into shares of stock.