Monthly investing via DRIP
Compound interest may be a miracle, but a monthly investing plan is at least as miraculous. If you add, say 300 EUR or USD each month, it is much easier to obtain a large savings egg compared to investing a lump sum because:
- It’s only a small amount each month
- You contribute in ups and downs. The downs will give your savings a big push. It’s also known as dollar-cost-averaging
- No market timing. Blindly dump the same savings amount at the end of each month in an ETF
- No adverse psychology in market downturns. The contributions during the lows will add to the account and the loss at the end of the year is much less or none compared to a buy-and-hold portfolio. You panic much less if you see a -10 % in your portfolio vs a -18 % or – 23 %
- There are brokers where you can minimise costs even for small monthly contributions. This is reality for one of my current brokers (Degiro, for a series of ETFs)
- Individual companies which allow purchases of their stock in small pieces are called ‘DRP’ (‘DRIP’) (Dividend Reinvestment Plan) or ‘DSP’ (Direct Stock Purchase Plan). You bypass the broker and set up a savings plan directly with the company. For companies that don’t have such scheme, brokers such as ShareBuilder, FOLIOfn, and BUYandHOLD.com offer similar services
Can we get an impression of the returns and is there a way to improve returns?
Normal monthly savings returns
These are the rules:
At the start of my career, 1990, I save 300 € into a stock market ETF which tracks the S & P 500. The monthly savings amount is indexed / tracks inflation in order to have a realistic amount throughout a 28 – year career. This is continued until today. Inflation (average over these 28 years: 2.0 %) has turned this monthly savings contribution into 528 /month today.
Result of the SP500 – DRIP plan
Looks fantastic isn’t it? The annual growth rate is calculated using 14 years, half of 28 years, because you do not have the return on the full savings during the full duration. Anyhow, you save a nice amount, 136 k, and you get 571 k in return at age 53. All that from a fair and certainly not excessive savings amount each month.
The only question bothering me is this: you put money in the account on market dips and market highs. The contributions at the highs obviously do not grow as much as during the dips. What if you would not put money in it during the highs? There are two issues with this:
- You never know when there is a top or bottom of the stock market
- What do you do then with the savings when you don’t invest in a given month?
Improved DRIP investing
My answers are:
- You do not know about tops and bottoms, but you do know when a market is excessively high or low. This doesn’t mean that you know what the stock market will do: from a excessive low, it could very well go much lower even for a long time (before going up again) and vice versa. Using my simple exponential curve (see here) is a simple way to have a basic idea, using other indicators such as the Shiller CAPE index would give a more refined view; Again, it’s not about an exact number, its about knowing that a PE of 35 means expensive and a PE of 10 means cheap.
- When you don’t invest the monthly amounts, you put them aside on a savings account. When the market is ‘cheap’ again, you start using this money to purchase additional stock/ETF (additional to the regular purchases with the regular monthly contributions). To keep things simple, I add a portion of x % of this savings account where x is the relative undervaluation of the market vs the simple exponential curve. For example, if I have not invested 300 $ during 20 months, there is 6000 $ set aside. If the market the next month drops 10 % below the exponential curve, I purchase an additional amount of stock for 10 % of the 6000 saved = 600 $. This way, the excess savings are slowly absorbed during lower market times.
Returns of this improved DRIP
There is a small advantage over the non-stop DRIP investing but it is not huge. The return on your actual investments (not considering the savings) is 12.8 % which is a big improvement, but the culprit here is the large cash amount which is left over because were are not adding any savings since 2013.
The evolution of the savings account and extra contributions from that savings account is easy to see on a chart:
There are a few periods to distinguish:
- 1996 – 2001: market expensive – building up savings (green line)
- 2001 – 2003: market cheap – monthly additions (black lines) from these savings, savings decrease
- 2003-2008: savings increase again
- 2008-2010: additions to stock / ETF, savings completely depleted
- 2013-today: savings build up again, no downturn until today so stacking up the money.
It will be worth re-doing the exercise after the market has gone down and savings are reinvested again.