My do-it-myself mutual fund

The author's smart solution to her problem could benefit even experienced investors.

By Carole A. Sofio, MD
Internist/Orange, CA

Not many college-educated 54-year-olds would admit they had saved almost nothing toward retirement, but that was my story a few years ago.

There were reasons, though. When I was 40, I divorced and left my career as a manager of clinical research at a pharmaceutical company to enter medical school. I sold my house to pay for my education, and remarried during my internship. Ten years later, in 1990, my husband and I had paid off most of our mortgage and had some money in a 401(k) plan—but only about $95,000.

Although we had few debts, we didn't get serious about investing until 1996. We enrolled in a financial planning course at the University of California, Irvine. Directed toward lay people, the class met once a week for six weeks.

Each week, we covered a different topic: estate planning, insurance, equities, and so on. One of the more interesting discussions dealt with the comparative costs of owning mutual funds and individual stocks. I'd assumed that because funds were so common in 401(k) plans and in individual portfolios, they'd make perfect sense for us, too. But the more the lecturer spoke, the more my conservative nature balked. I learned that many funds have hefty fees associated with them, including upfront commissions or "loads," and ongoing expenses that can total 1 to 2 percent annually. Some fund companies charge additional amounts that go toward marketing campaigns.

Moreover, if investors panic and dump their shares, the manager might have no choice but to sell some of the fund's best holdings to meet its obligations. I didn't like the thought of that.

Owning individual stocks would clearly give my husband and me more control over our destiny. However, most brokers prefer to sell "round" lots of stock, equivalent to 100 shares. We wouldn't have been able to afford that for very many companies. It would have meant putting our eggs in only a few baskets—not a wise choice. That's when the instructor mentioned something called DRIPs—dividend reinvestment plans. Hundreds of US companies and some foreign firms offer DRIPs. They allow investors to automatically reinvest the dividends earned on a company's stock or buy additional shares direct from the company. For advice on how to get small, "odd lots"—or as few as one share, which is all that many companies require you own—refer to the print and Internet resources mentioned later in this article.

After enrolling in a DRIP, shareholders can also invest more money on a regular basis, in amounts as small as $10 or $25, and there are usually no fees or commissions to do so. However, there's no obligation.

Why do companies bother to offer DRIPs? For one, folks who invest in them tend to have a buy-and-hold mentality, which helps create a core of long-term shareholders. This, in turn, can help stabilize the stock price. Second, DRIPs allow companies to hold on to money rather than paying it out in cash, risking the possibility that shareholders spend it or invest it elsewhere. DRIPs may also hold off a company's need to raise additional capital.

The biggest drawback of DRIPs is that the company processes your purchases and sales on its own schedule—the absolute antithesis of day trading. (If you wish, though, you can ask the company for the actual stock certificates, so that you can sell your shares when you want to, through a broker.) This is a minor inconvenience for us, because we view our holdings as long-term investments and believe in the overall strength of the American economy. When the economy rebounds, we feel that blue-chip companies will lead the way. We don't own any stocks of small- and medium-sized companies. In fact, a few years ago, because we're both very conservative and are uncomfortable owning volatile stocks, we rolled over the money from the 401(k) plan into money-market accounts.

Before we enrolled in a single DRIP, we educated ourselves. We bought Charles B. Carlson's book, Buying Stocks Without a Broker (McGraw-Hill Trade, 1996), which provides lots of good tips for getting started. Carlson, a financial analyst, is also the editor of DRIP Investor (www.dripinvestor.com), a monthly newsletter. Another good resource is DRIP Central (www.dripcentral.com). It includes links to the home pages of dozens of companies that offer dividend reinvestment plans. Once you reach a home page, look for the "Investor Relations" or "Investor Information" tab for more on DRIPs.

After doing our homework, we established three rules: First, we would diversify our holdings over as many different market sectors as possible. To do this, we selected 20 large-cap companies, including BellSouth, Disney, ExxonMobil, Fannie Mae, Home Depot, Lucent, Merck, Procter & Gamble, and Reuters. In all, we established small positions in agriculture, chemicals, communications, energy, entertainment, finance, insurance, pharmaceuticals, and real estate, and a few other sectors.

Second, to spread our risk, we placed no more than 5 percent of our assets in any stock. We invested $1,000 in each of the 20 companies and pledged to ourselves that we'd rebalance our portfolio if it became overweighted in any one stock.

And, finally, we wouldn't time the market. Instead, we'd invest on a regular schedule to take advantage of times when shares prices are low, something known as "dollar cost averaging." A small transaction or service fee occasionally applies to these subsequent purchases, but we've never paid more than $5.

By and large, once you understand how DRIPs work, transactions run smoothly. But one time, we were confused when our confirmation from ExxonMobil showed that we had been issued twice as many shares as we'd expected. As it turned out, we had lucky timing—the stock had split. That didn't change the total value of our shares; however, a split usually heralds a rise in the stock's price. In this case, ExxonMobil went from $53 to $64 in less than three months. In all, eight of our original 20 stocks have split since we've owned them.

To monitor our assets, we use a free portfolio tracker at PCQuote.com (www.pcquote.com), and we keep separate hanging files to store copies of our purchases. We also keep each Form 1099-DIV we receive. Our accountant gets all of these, because even though dividends are reinvested, they're still taxable.

Our stocks have experienced considerable ups and downs over the past few years, as most have. Early in 1998, we paid 108 a share for Lucent; it's trading at less than 2 these days. We sold $3,000 worth of those expensive shares last year, to help us take the maximum allowable annual deduction for investment losses. No doubt we'll sell more Lucent shares this year if the company fails to revive.

On the plus side, Duke Realty, a publicly traded real estate investment trust based in Indianapolis, has been our biggest success. We've been rewarded with a 69 percent return on our money since we first started buying shares of the company in 1998.

As I mentioned earlier, we're confident that large US companies like the ones we own are going to lead the recovery. As such, we continue to hold positions in all of the stocks we've purchased, including Lucent.

Unfortunately, our buy-and-hold strategy has cost us in the short term. Although we had close to $92,000 in our account a few years ago, before the market started foundering, our account balance currently stands at a little more than $75,000. We're both thrifty, though, and we plan to work and contribute to our DRIPs for at least several more years. Between those, our Social Security checks, my husband's pension, and our money-market accounts, we should do well enough.

For us, the benefits of investing in DRIPs have far outweighed the negatives. By running our own portfolio, we feel safe from investor hysteria and in control of our money. Plus, unlike owners of mutual funds, we don't get hit with administrative fees or owe capital-gains taxes on stocks that have been sold. If you have the time and discipline to research companies and monitor your stocks, creating your own "mutual fund" is definitely the way to go!

 

Carole Sofio. My do-it-myself mutual fund. Medical Economics 2003;7:83.