The pros and cons of dividend reinvestment plans

We analyze a wide range of investments in Canadian Wealth Advisor, our newsletter for safety-conscious investors. These include the 19 common stocks we’ve selected for our “Safety-Conscious Stock Portfolio.”

All these stocks are well-established companies with bright prospects and strong positions in healthy industries. As well, almost all offer dividend reinvestment plans, or DRIPs.

DRIPs let shareholders reinvest dividends to buy additional shares (or fractions of shares) of the company. DRIPs bypass brokers, so shareholders save on commissions.

Dividend reinvestment plans: a convenient way to cut investment costs

Aside from the commission savings, DRIPs eliminate the nuisance of depositing or reinvesting small cash dividend cheques. As well, many DRIPs allow optional commission-free share purchases on a monthly or quarterly basis.

To participate in a DRIP, you have to buy one or more shares of a company’s stock, and get a certificate registered in your name. Share registration (through a traditional or discount broker) can cost $40 or more per company. Then you call or write the company to ask for the form you fill out to enrol in the plan.

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Not all stocks that offer dividend reinvestment plans are good investments

We think DRIPs are okay to participate in if you use them to cut commission costs on stocks you would have bought anyway. But confining your investments to stocks that offer DRIPs is a terrible idea. That’s because not all stocks that offer DRIPs are good investments. And you can lose a lot more on these stocks than you could ever save on commissions.

That’s why we don’t focus exclusively on DRIPs when we select stocks for our newsletters, including Canadian Wealth Advisor, though as we mentioned, almost all of the stocks the newsletter recommends do feature them.

DRIPs have lost some of their cost-saving advantages

DRIPs offer much less of an advantage now than they did in, say, the 1980s, when brokers charged 2% or more to buy stocks. Now, thanks to the growth of discount brokerage and Internet competition, you can buy stocks for a commission cost of 0.5% or less. In addition, many companies that offer DRIPs have done away with the 5% discounts that used to be common. Now you pay full price to buy through most DRIPs. But DRIPs are still a handy way to reinvest small dividend payments.

Here are a couple of other things to keep in mind when participating in DRIPs:

• Taxes are still payable on dividends that you reinvest.
• You’ll need to keep careful records of all purchases to compute capital gains and losses when you sell. Many investors find this particularly troublesome, especially when they inherit the task.

We’ll keep you updated on safety-conscious investments, and strategies you can use to increase your profits with lower risk in our Canadian Wealth Advisor newsletter. Click here to learn how you can get one month free when you subscribe today.