Next, taking the rose-colored glasses off:
I've read a number of articles on financial blogs lately touting the virtues of investing in in corporate DRIP programs. While I have no argument with dividend oriented investing, and certainly not with reinvesting dividends, I do have a problem with the notion the road to wealth for Joe Investor is through DRIPs. The sales-pitch for DRIPs typically runs along the lines of buy a dividend achiever type of blue chip stock with an above market yield, compound the interest and grow rich over the years as the dividends and earnings grow. Tales abound of investors who bought Coke, IBM, or Proctor & Gamble 40 years ago, reinvested dividends to astonishing returns. No one talks about the companies who performed poorly or went out of business. The small-time DRIP investor almost by definition will be a concentrated investor, with typically no more than 15-20 holdings tops. So what happens to that type of investor if they are unlucky and end up sinking a large percentage of their wealth into the DRIP of a dividend achiever like WaMu? What happens if they pick the wrong 15-20 stocks? Is the risk worth it?
No less an investor than famed value guru Bill Nygren of the concentrated Oakmark Select fund had as much as 17-18% of that fund invested in WaMu during the company's go-go days. Nygren has compiled an impressive record running his fund, but how could he have been so badly fooled? In the chart below, the blue line indicates how Oakmark Select fund performed compared to its peers (orange line) and the market as whole (green line).
I think you've given a good example of why "there's no such thing as a free lunch". DRIPs work - until they don't. And when they don't they can really damage a portfolio. They tend to create complacency in that funds are automatically reinvested.
ReplyDeleteA problem you diidn't mention is the cost basis issue with DRIPs in a taxable account.
You list a number of companies that went under or had to be rescued. I think we are still in a state of shock and have yet to fully realize what happened in 2008. If you had told me as recently as 2005 that Fannie Mae, Freddie Mac, Merrill Lynch, Lehman Brothers, AIG etc. would end up like they did I would have laughed in disbelief.
I can tell you that many many people lost a lot because they were not properly diversified. They were not as badly damaged as the Enron employees who put everything into one company but their dreams of retirement were destroyed. These are people you will never hear about. These are people who followed Bill Miller and other "gurus". They bought a few stocks and then doubled down as the stocks dropped. They got excited as Cramer shouted boo-yah and touted the stocks.
This of course is the non-ending story of the stock market. It is a place where people can gamble. They do and they will. Some win big just as they do at the race track. Many more though suffer serious setbacks because their emotions take over and they ignore well reasoned, well thought out principles of investing.
It so happens that for the first time in history people can fairly easily retire for many years comfortably as long as they save and invest wisely and are somewhat frugal. Unfortunately, greed takes over.
You're right about the cost basis problem. Very careful and detailed records must be kept by the investors for a long period or time. Easy to get lazy or careless and screw that up. I hadn't intended to cover that issue in this post.
ReplyDeleteI work with a bunch of WorldCom "millionaires" who put their entire 401Ks in company stock. They gambled and lost, and now will be working many more years than they originally thought. I see DRIPs as being an extension of that kind of thinking. They will work out well for some, and be devastating to others based more on luck than skill. There is a simpler and less-risky option that most should be using instead of DRIPs.