Covered Calls, Dividends & Passive Income

I would like to start off by saying I am a big proponent of dollar cost averaging. Why, because it is a way for individuals to invest a small amount in stocks and EFTs without having to commit a large sum of money for an initial investment. Most individual investors do not have a large sum of money to commit all at once and need to take small steps to build their portfolio.

I used to have a traditional brokerage account, but like most people found it costly to purchase one or two shares of a stock per month. I think this why you see so many individual investors look at stock under $20 so they can get a large number of shares for relatively small investment. I used to be one of these people and to a certain degree still am, but I am trying very hard to stop this. Swinging for the fences on lower priced stock is a risky strategy and at least for me often turned into a losing bet. Remember stocks are generally “cheap” for a reason. Dollar cost averaging either through the company’s DSPP or a broker that specializes in this service opens up to people stocks that they may normally never look at because the per share cost is to high.

What is dollar cost averaging? It is investing a fixed dollar amount typically each month in a single investment (stock or mutual fund) or baskets of investments, with the premise that more shares are purchased when the investment is priced low and few shares when it’s priced high.

I know this method of investing has some detractors and I will try to cover their rationale in a later post, but since I support this type of investing lets start with some of the benefits as I see them.

1. Reduces risk, especially during time of high market volatility
2. Allows small investors to purchase shares in high-quality companies without a big initial investment.
3. Can be less costly than a traditional broker.
4. Fractional shares

What you do get with dollar cost averaging is lower risk and possibly a lower investment cost. In times of high market volatility it can reduce your average per share cost. Here is how I personally use dollar cost averaging to invest.

I still have three Direct Stock Purchase Plans (DSPP) / Dividend Reinvestment Plans (DRIP); they are WOR, J&J and PNY. These plans charge no fees for optional cash purchases, and the PNY offers a 5% discount on reinvested dividends. I still regularly contribute money to them. I have cashed out several plans recently because it just became to unruly to track my investment. Plus I didn’t like the fact that I couldn’t immediately sell a stock if the situation warranted. Enron used to have a DSPP I can only imagine all the poor people that got stuck waiting a month or two to get out of that investment.

Right now I have a ShareBuilder® account through ING Direct. This account works for me because it allows me to invest in any stock, EFT or mutual fund, in any amount at a wide variety of time intervals. I get fractional shares of stock and my dividends are automatically reinvested. It also offers real-time trades at a cost similar to most online brokers. Also, I can write Covered Calls through their service, which is something I am just getting into and will write more about in a future posts.

Obviously this service is not free, but compared to a traditional brokerage account I have found their costs to be much less for a dollar cost averaging investment approach. I have a Standard Account that costs me $12.00 a month and allows me to invest in up to six (6) stocks, EFTs or Mutual Funds and I if want to invest in more the cost is $2.00 per transaction. If I invested in six different stocks per month through an online broker at $9.99 per trade it would cost me $59.94 in commissions, OUCH!!

Two last words on why I have a ShareBuilder account. One, is I can execute a real time trade to either buy or sell a stock if the situation warrants. This is one feature you do not have when participating in a company’s DSPP / DRIP. Two, is I get fractional shares of stock. For example, if I want invest $400 in 3M @ $68.72 per share and use a traditional broker I would get five (5) shares and would have $56.41 left over not counting commissions. With fractional shares my $400 gets me 5.821 shares. This keeps more of my money working for me in the investments of my choice. This means 14% more dividends, 14% more capital appreciation and 14% more cash flow available for reinvestment.

Remember always buy the underlying stock if participating in a DSPP / DRIP. This is a long-term form of investing.