Wes Moss: Perfect holiday gift for your nest egg

Certified financial planner Wes Moss provides personal finance advice and accessible investment strategies. His guest post appears here weekly.

One of the biggest challenges investors face is cost. As I recently explained in The Seven Layer Dip of Fees, there is nothing more detrimental to your long-term rate of return than high-cost investment vehicles – except maybe emotional and excessive trading.

Most mutual fund investors and variable annuity owners face annual costs between 1% and 3% – sometimes more. In a stock market that historically has barely averaged a return of 9%, paying 3% in fees every year eats away over one third of your return – and that’s before taxes.

So, as a holiday gift, allow me to introduce you to the DRIP account, one of the best, low-to-no cost ways to buy individual stocks. DRIP stands for Dividend Reinvestment Plan. Unlike a mutual fund or ETF (exchange traded fund), individual stocks have no internal management fee, but typically require a transaction or trading cost to buy or sell. A DRIP program helps mitigate these charges.

Why?

Because you buy the stock straight from the source. When you purchase shares through a brokerage firm like Charles Schwab or Fidelity you are dealing with a middleman. In a DRIP program, you are actually acquiring stock directly from the company at prevailing market prices. Sometimes the company will allow you to buy the shares at a discount, typically ranging from 1% to 10%.

When you are ready to unload the stock, you have two options: You can sell it back to the company at fair market value, or transfer the shares into a brokerage account and sell them on your own.

DRIPs are easy to set up. Get started by visiting the website of the company you are interested in buying and do your due diligence.  Some companies have minimum investments of as low as $1 – you can use the search feature on Computershare to find your desired company.

Each time you receive a dividend from the stock that you own in a DRIP, that cash will go toward buying more shares in the company. If the dividend amount only covers a portion of the cost of one share, you will receive a fractional share, which is a nice perk for smaller investors.

A DRIP program is also an excellent way to ensure that you adhere to the wisdom of “dollar cost averaging.” Basically, a DRIP allows you to add to your holdings every time you receive a dividend, usually once a quarter. That dividend amount automatically buys more shares regardless of the price. This way you are forced to expand your holdings whether they are up – or down – thus avoiding the trap of buying too much at a peak price and too little at a lower price.

Now that you’ve unwrapped it, don’t stick the DRIP up on a closet shelf. Take it apart, study it, play around with it – decide if it’s for you. If not, you won’t hurt my feelings. But I suspect that once you see how a DRIP can maximize the return on your hard earned money it will prove to be one of your favorite gifts.

- By Wes Moss, for The Atlanta Bargain Hunter Blog