Sunday, June 12, 2011

DRIP: Compound Interest On Steroids

Here's a great book by Derek Foster for anyone who's starting there investment journey. This book teaches you some of the basics about investment. The best concepts covered in this book are:

1) Dollar Cost Averaging
2) Dividend Re-investment Programs (DRIP)

Dollar cost averaging is a concept where you consistently invest a set amount of money regardless of how the individual security or market is performing.

Using this method allows you to purchase more shares when the price is down and less shares when the price is up. Over time you'll end up owning more shares at a lower average price. This method takes advantage of price fluctuations and market volatility. Here's an example I found of dollar cost averaging at the www.theshapeofmoney.co.nz:

You're able to regularly save $100 per month.

In May, the units cost $1 each, so you're able to buy 100 units.
In June, the cost of the units falls to 95c, so you're able to buy 105 units.
In July, the cost of the units again falls, this time to 85c, so you're able to buy 118 units.
In August, the cost of the units rises to $1.05, so you're able to buy 95 units.

At the end of August, you own 418 units. The cost of the units is now $1.05, so your total investment is worth $439.

The cost of your 418 units over the four months was $400, so the average cost of each unit was 96c.

Your investment has increased from $400 to $439.


The second concept covered in this book is dividend re-investment plans or DRIP's. A DRIP is where a company offers its shareholders the option of re-investing their dividends into the company by purchasing more shares. Some companies even offer a discount which is a super attractive deal (sometimes up to 5% off the share price with the dividends re-invested).

Even if there is no discount on the share price, you can avoid hefty commission charges by signing up for this plan. Also you are using dollar cost averaging to your advantage.

Only some companies offer a DRIP so it's important to check before purchasing shares. Here is an excellent site introduced by The Lazy Investor which lists all the companies on the TSX with DRIP's http://cdndrips.blogspot.com/ .

DRIP's are an incredible way to compound your growth. If you've picked a great company and the share price increases over time and you are enrolled in the DRIP program your investment will grow astronomically. Not only will you be owning more shares over time, but as you own more shares you'll receive more dividends as a result. Which means you'll be purchasing more shares each time dividends are paid. It's a vicious cycle of wealth creation!

Check out this great video from money.com about DRIPS

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