Dollar-cost Averaging Powers Dividend Farming

Dollar-cost averaging is an integral part of DividendFarming.  It’s a powerful method of growing a great financial crop.  The best part; it’s simple and automatic.

In a nutshell, dollar-cost averaging means contributing an amount of money to your investment portfolio to purchase stock on a monthly basis.  You could also do so quarterly, but monthly is advantageous due to the increased number of compounding periods.  The more the merrier, but I digress.  As an example, you might purchase $100 worth of stock each month and do so irrespective of whether the stock’s price has increased or decreased.

Courtesy of JP Morgan

With dollar-cost averaging you may purchase a few shares at high prices, but you are also likely to purchase more shares at lower prices.  The table below demonstrates the principle using the $100 example mentioned previously.

Month	Share Price	Shares Purchased
January	$25	4
February	$28	3.5
March	$27	3.7
April	$23	4.3
May	$20	5
June	$22	4.5
TOTAL		25

You will have purchased anywhere from 3.5 to 5 shares per month with your $100 investment as long as you were disciplined about putting money into your brokerage account and making the purchase. 

Brokerage Fees and Partial Shares

Realistically, if you were making the purchases with contributions to your account, the stock purchase figures would be lower because you would have paid a brokerage fee each time you made a purchase.  If a broker charged you $5 for each trade, you would be investing only $95 per month to buy stock.  Consequently, the quantity of stock you buy each month would be lower than shown. 

It should also be noted you can’t buy partial shares this way.  This means another portion of your $100 would be unavailable to use for purchases each month.  This money could be held in the account and used to supplement your purchase the following month, but you still miss the full effect of dollar-cost averaging.  The next table offers clarity.

Month	Share Price	Commission Fee	Funds Available	Shares Purchased	Balance
January	$25	$5	$95	3.0	$20
February	$28	$5	$95	3.0	$6
March	$27	$5	$95	3.0	$9
April	$23	$5	$95	4.0	$3
May	$20	$5	$95	4.0	$10
June	$22	$5	$95	4.0	$7
TOTAL				21	$56

In this example, which is more realistic, you would purchase only 21 shares during the same 6-month period versus the previous case.  You would contribute $30 to your broker for the privilege of making the purchases.  An additional $56 of your $600 in investment funds accumulated in the account because you can’t purchase partial shares. 

Based on the purchase prices shown, you would have to accumulate the leftover funds for about 3 months before you could use them to purchase an additional share of stock.  You effectively lost $86 ($30 + $56) or 14.3% of your investment to the broker or the opportunity-cost associated with not being fully invested each month.

Ok, if you lose a large chunk of your investment funds in the dollar-cost averaging example shown, how can that be beneficial to you as a dividend farmer?  When farming dividend stocks, the dividend payments can be accepted into your brokerage account as cash and reinvested in additional dividend stock.  Managing your dividends this way results in the kind of attrition highlighted in the second table.

DRIP Strength

However, if you have your dividend payments automatically reinvested in the companies paying them, you avoid the brokerage fees and you’re allowed to purchase partial shares.  When you receive $600 worth of dividends and reinvest them in a DRIP, you put the full $600 to work for you, compounding all the way, increasing your crop yield.  

This is the true power of dividend reinvestments.  Additionally, you’re assured of automatic contributions to your portfolio each month.  Efficient, disciplined investing maximizing your ability to grow a healthy dividend crop.  Who doesn’t like that?

   

The thoughts and opinions expressed here are those of the author, who is not a financial professional.  Opinions expressed here should not be considered investment advice.  They are presented for discussion and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.