Thursday, October 21, 2010

How to Get Rich Slowly DRIP by DRIP: Transaction Costs Compared to Mutual Funds

You pay less for the privilege of investing in a DRIP account compared to mutual funds. Paying less means more of your money works for you - increasing your net worth.

The transaction costs for HAS (Hasbro), a typical DRIP stock, were discussed in the previous post. Hasbro’s fee schedule is reproduced below.

Example Fee Schedule
The fee structure for Hasbro (HAS) is:

DRIP vs Mutual Fund – Head to Head
In the following Excel spreadsheet you can see the effect of equal investment streams going into a DRIP account compared to a no-load mutual fund with zero brokerage commissions, a 1% annual management fee, 4% reinvested dividend yields, and 6% annual net asset value (NAV) growth. These are pretty decent numbers for a mutual fund. Few have done this well over any significant time period.

After 25 years the mutual fund’s value grows to $56,609.17. The same investment stream in a DRIP grows to $64,858.64 – a difference favorable to the DRIP of $8,249.47; A much larger difference than buying individual stocks thru a broker.

Why? Because the 1% management fee is 1% of the entire value of the investment – every year. Brokerage commissions are incurred only when you buy or sell. Frequent trading will cause commissions to mount up fast. But, if you hold high quality stocks for the long term commissions are insignificant.

What If?
This example is designed to be favorable to the mutual fund. Few mutual funds yield 4% dividends and few have management fees as low as 1%. Only index funds are that efficient and not all of them.

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 affect results. For example, changing the annual management fee to 0.5% reduces the difference to just $3,086.64 – still much more than when DRIPs are compared to buying and holding stock thru a broker.

The topic of the next post is Dollar-Cost Averaging.

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

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