Creating a DRIP Stock Portfolio

Whether you’re just starting out or have been investing for a number of years, you may think that creating and maintaining a stock portfolio is a daunting task--one you might better leave to the professionals. The truth is, however, that you can minimize investment risk and cut your investment costs by doing it yourself. The process is not as difficult as some would have you believe. In fact, it can be fun.

Some generalities can be observed, such as to own growth stocks when you’re young, income stocks when you’re older. But even these ideas have changed over time as a result of such factors as taxation and lifestyle. For example, the traditional advice to own income-producing stocks as one approaches retirement is not as valid as it once was, simply because people are living longer and may need to continue to own growth stocks to a greater degree than before. Likewise, the notion that very young investors can...or perhaps should...take more risk should be taken with a grain of salt. While they can benefit from compounding over the course of several decades, that benefit is lost if they gamble...sometimes almost literally...on stocks that are too risky, and end up losing it all. That can set the young investor back years at a time.

... their investors with unwanted taxable capital gains distributions (that can occur even when the fund is down). And they may be left clueless about the companies owned by the fund.

Picking stocks for a good portfolio doesn’t need to be intimidating. Even legendary fund manager Peter Lynch, who once ran the largest mutual funds in the country at Fidelity, has stated that individuals really have the advantage over fund managers. He urges people to start by “buying what they know” and holding for the long term. DRIPs give people an additional advantage. Since you can invest through a DRIP without going through a broker, you can invest small amounts on a steady basis, rather than having to save up several thousand dollars and risking it all at once. In addition, you remove one element of risk--that is, broker risk.

“Buying what you know” simply means investing in the companies whose goods and services you...and millions of other consumers...use daily. Of course, that’s just a starting point, but, as the saying goes, “a journey of a thousand miles begins with one step.” Combine this idea with the concept of owning a handful of basic industries...such as food, banking, oil, utilities, and health care...and building a portfolio may begin to seem manageable, even easy. What these industries have in common is that they provide goods or services that people need on a steady basis, making them somewhat recession-proof. Chances are that you can find at least one company in each of these industries that is familiar and is enjoying a lot of “repeat” business.

Making Choices

If identifying familiar companies is the first step, then the next is to determine which competitor represents the best investment. Remember that you’re focusing on the long term, not trying to “bet” on a company that may surge over the next weeks or months. If you feel the need to do that, it’s best to use separate funds that you devote to short-term trading. The shorter the time span involved, the greater the risk you’re taking if you’re betting on quick profits. But that’s not something you want to do with your retirement funds! Investing for long-term goals, such as retirement or college funding, requires discipline and, to some extent, a more conservative approach. Be wary of becoming too conservative, though, as this form of psychological inertia can lead you into locking yourself into mediocre returns. Starting with leaders in several basic industries can help avoid this, especially when you add top companies from a few other industries. It’s a good idea to start by comparing basic industries, using data from such sources as the Value Line Investment Survey, available at most libraries, or utilizing the plethora of online information sources, such as Yahoo! Finance or Google Finance.

Some common sense should be applied to stock selection. For example, companies that are laden with debt will have a hard time growing profits, just as individuals with hefty credit card balances will have a hard time saving any money, let alone investing. (Certain industries are exceptions, however, such as utilities that must borrow heavily to build new power plants, and banks, whose liabilities include depositors’ money.) Debt-laden companies not only must devote more of their operating profits to interest expense, but are also vulnerable to interest-rate hikes. Another basic yardstick is a company’s price/earnings (or P/E) ratio (the stock’s price divided by earnings per share). Under-discovered stocks will have lower P/Es than ones that are enjoying great popularity at the moment.

Investing for the Future

Stocks are often segregated into “growth” and “value” groupings, each with its own appeal. Growth stocks typically are increasing revenues and earnings at an above-average rate, but pay little or nothing in dividends. By contrast, value stocks have slower...albeit steady and reliable...growth and pay more in dividends. As a growth stock (and its industry) matures, its rate of growth may slow, so it rewards its shareholders by increasing its dividend to offer a higher yield.

Investing for the next several decades will require two commitments: getting started now and investing regularly over the years. As mentioned earlier, many people give in to the inertia of indecision and a feeling of helplessness, so they simply don’t get started. But as we’ve said, you are the best analyst you can find and, considering the track record of many mutual funds and market “gurus,” you’re likely to do at least as well as any “experts.” Buying the first share in order to enroll in a DRIP should help kick-start your investing experience. Once you have a DRIP statement (and the tear-off portion for additional investments) in hand, it’s far easier to get going. Hundreds of companies even let you set up automatic debits from a bank account, so there’s no excuse...even for the person who hates to write checks...for delaying the accumulation of wealth to meet your long-term goals. If you have very little to start with, you can begin with one DRIP and add others periodically until you have a diversified portfolio. Otherwise, starting with a handful of basic industries and adding others later will do the trick.