How to take advantage of dividend reinvestment plans

dividend-reinvestment-plans

Dividends and dividend reinvestment plans are in fashion with investors right now, and that’s always a good thing. After all, creative accounting can produce false impressions of prosperity and hide embarrassing financial problems. But accounting can’t create cash for this year’s dividend, let alone conjure up a history of past dividends. Did you know that dividends can produce as much as a third of your total return over long periods? Stick to dividend payers and you’ll avoid most of the market’s greatest disasters.

Dividends from Canadian companies come with a tax credit, to reflect corporate income taxes. This cuts your tax rate. (Note: the credit is non-refundable and can only offset income taxes owed. But you can transfer it to your spouse under certain conditions.)

Dividends will help you stay away from the market’s worst stocks

You should also keep these two important points in mind:

Dividends can grow. Stock prices rise and fall, so capital losses often follow capital gains, at least temporarily. Interest on a bond or GIC holds steady, at best. But companies like to ratchet their dividends upward—hold them steady in a bad year, raise them in a good one. That gives you a hedge against inflation.

For a true measure of stability, focus on companies that have maintained or raised their dividends during recessions and stock market downturns. These firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they provide an attractive mix of safety, income and growth.

Dividend reinvestment plans, or DRIPs, allow shareholders to receive additional shares in lieu of cash dividends. DRIPs don’t require the participation of brokers, so shareholders save on commissions.


The Power of Dividends

Dividends are more important than ever. Today’s low interest rates prompt more investors to look to dividend stocks for income. And dividend stocks are a source of strength in volatile markets, so many companies are raising their payouts. This is the time to build more strength into your portfolio with Pat McKeough’s “How High Dividend Stocks Can Supercharge Your Income Investing.”

Learn more  >>


DRIPs also eliminate the nuisance effect of receiving small cash dividend payments. Second, some DRIPs let you reinvest your dividends in additional shares at a 5% discount to current prices. Third, many DRIPs also allow optional commission-free share purchases on a monthly or quarterly basis.

Generally, investors must first own and register at least one share before they can participate in a DRIP. Registration will generally cost $40 to $50 per company. The investor must then notify the company that he or she wishes to participate in the company’s DRIP.

There are also separate dividend reinvestment plans that are available through most discount brokers (these are called “synthetic DRIPs”). The bookkeeping is simpler with these DRIPs. Under these plans, brokers will reinvest dividends on shares that you hold in your account. Not all your dividend stocks may be eligible for these plans.

Overall, we think that dividend reinvestment plans are okay to participate in. But we think there are a few important points to keep in mind:

  • Many investors make their investment choices solely on the basis of the existence of the DRIP option. We think the availability of a DRIP is only a bonus, rather than a reason to invest by itself. Investing only in stocks that offer DRIPs limits both investment choice and opportunity.
  • The advent of the low-cost discount brokerage and online investing has reduced the commission cost of investment trades. Thus, the commission-free investing that DRIP investing allows is less of an advantage today than it was in the past.
  • Taxes are still payable on dividends that are reinvested.

Most companies that offer DRIPs provide details on their web sites. Another place to look for information is the inside back cover of most companies’ annual reports. You can also contact the investor relations department of companies you wish to invest in.

Do many or most of the stocks in your portfolio contain specific “rewards” for investors—dividends, share buybacks or a dividend reinvestment plan? Which of the three has the greatest appeal for you?

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