16 Mar DRIPs or dollar cost averaging?

Q. Am I better off with DRIPs or just with dollar cost averaging into an index fund?
— Investor

A. Both investing strategies have lots of positives, but dollar cost averaging alone may not do the trick.

From a diversification standpoint, you are better off taking the approach of dollar cost averaging into an index fund, said Brian Smalley, a certified financial planner with RegentAtlantic in Morristown.

That’s because DRIPs — dividend reinvestment plans — are set up to reinvest the dividends of individual company stock.

“More than likely you would have less stocks in your DRIP portfolio than that of an index fund which would lower the diversification of your portfolio,” Smalley said. “On top of that, you would be buying more of the same stocks over time, therefore, increasing your concentration in those individual stocks.”

But DRIPs do have the benefit of automatic reinvesting – which in of itself is a form of dollar cost averaging, Smalley said.

“This takes the discipline and emotion out of the decision of whether or not to keep investing into your strategy, which may be the biggest drawback of completing a dollar cost averaging strategy into an index fund,” he said.

One way you can combine the automatic reinvesting benefits of a DRIP and the broad diversification benefits of an index fund is to have the automatic reinvestment of any dividends or interest paid out by the index fund back into the index fund, he said.

“There are brokers who will set this up for free and not charge a commission on the reinvestment,” he said. “If you are having trouble locating a broker who will set this up for you, look for an advisor who not only can assist you in setting up your dollar cost averaging plan, but who can help you stick with it in both good times and bad.”

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This story was first posted in March 2016.