Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you specific investment tips and stock market advice. Each Investor Toolkit update gives you a fundamental piece of investment advice, and shows you how you can put it into practice right away.
Today’s tip: “Dividend Reinvestment Plans have attractive features, but they shouldn’t be the sole reason you invest in a stock—or limit yourself to a portfolio of DRIPs.”
Dividends 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. Stick to dividend payers and you’ll avoid most of the market’s greatest disasters.
Some companies provide dividend reinvestment plans, or DRIPs, that allow shareholders to receive additional shares in lieu of cash dividends. DRIPs don’t require the participation of brokers, so shareholders save on commissions.
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.
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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.
COMMENTS PLEASE—Share your investment experience and opinions with fellow TSINetwork.ca members
If you own stocks with DRIPs, what is the chief benefit you get from holding them? Do they make up a sizeable portion of your portfolio?
Note: This article was previously published on December 13, 2012.