Tuesday, October 12, 2010

How to Get Rich Slowly DRIP by DRIP: Transaction Costs Compared to Brokerages

You pay less for the privilege of DRIP account investing compared to using a broker – or mutual funds, but that’s another post.

Paying less to play means more money goes into your investment - increasing your net worth.

You buy stocks for your DRIP plan directly from the stock issuing company. The “Transfer Agent” merely administers the transactions. This means each DRIP plan can have a different fee structure. Some plans charge fees for purchases, some discount the purchase price from the current market price. All charge a fee when you sell.

Example Fee Schedule
The fee structure for Hasbro (HAS) is shown below.

HAS doesn’t allow buying the initial investment thru the plan administrator (Transfer Agent). You must transfer at least one share from your broker or mail an actual stock certificates to set up the account. As shown in the table above, there’s no fee to set up the account.

After the account is set up you can buy additional shares thru the Transfer Agent without fees. If you buy shares thru a broker you will pay a brokerage commission with each transaction. As a point of reference, my transaction costs thru my broker are $5.95 per transaction.

DRIP’s Aren’t for Trading
My broker charges the same $5.95 per transaction whether I’m buying or selling. You can see in the chart that Hasbro charges $10.00 per transaction PLUS $0.15 per share when you sell. So if I sold all of my HAS shares – assuming I owned 100 shares – my DRIP selling cost would be $10 + $15 (100 shares * $0.15/share) = $25 compared to only $5.95 if I sold the same 100 shares thru my broker. DRIP accounts are not for trading.

If you accumulate shares in your DRIP and hold them for the long term, the DRIP is very efficient in terms of transaction costs. None are charged on your monthly purchases. If I bought shares monthly thru my broker I’d pay $71.40 a year compared to zero in my DRIP. The higher DRIP selling fee is overwhelmed by the commissions charged on regular purchases of stock thru a broker.

DRIP vs Brokerage – Head to Head
In the Excel spreadsheet below you can see the effect of equal investment streams going into a DRIP account compared to a brokerage account given $5.95 brokerage commissions, 4% reinvested dividend yields, and 6% annual growth in earnings per share (EPS).

After 25 years the Brokerage investment stream grows to a value of $64,279.42. The same investment stream in a DRIP grows to $64,858.64 – a favorable difference to the DRIP of $579.22. Not much over 25 years.

What If?
This example, however, is designed to be extremely favorable to the brokerage account. There’s no trading and the buys are lumped into annual purchases of $600 each. In the DRIP, the annual $600 investment could be monthly purchases of $50 each – still with zero transaction costs. An equivalent investment stream in the brokerage account would reduce the value of the account to $57,197.38 – a favorable advantage to the DRIP of $6,950.58.

You can change the parameters in this spreadsheet.

Experiment with different commission fees, dividend yields, EPS growth rates or annual investments and see how they would affect results

In the next post, I’ll compare DRIP account investments to mutual funds. I think the results will surprise you.

Link to Topics in the Special Report - How to Get Rich Slowly DRIP by DRIP

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