Investor Toolkit: A critical look at the pros and cons of Dividend Reinvestment Plans

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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:

  1. 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.
  2. 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.
  3. 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.

Comments

  • William W.

    You need to closely watch the stock’s performance when you are in the DRIP plan. If the price continues to drop it will not be to your advantage since you now own more shares but the total value is now even less as if you had not entered the DRIP plan in the first place.
    Taxation. If you would like to pay your accountant his hourly fee to calculate your taxes with all these bits of information he has to round up, you can be my guest. I have found it is better for me to accumulate the dividends in cash until I have enough money to buy more shares of the same company if I deem them worthy to buy. Thanks for listening

  • Harold H.

    You missed the biggest issue with DRIPS – unless you hold them until you die you lose more than you gain by having to sell odd lot shares which the majority of time are at much lower than market price plus brokerage fees for a separate transaction just to move them – DRIPs are a fur lined mouse trap for small investors who do not have the leverage with brokers that the institutional buyer has.
    HHH

  • I have not bought a DRIP just because the company had one. I have one in Scotia bank because it reminds me that prices go up and down and the company stays sound. I think it is a great saving tool and I just set one up for my new granddaughter. In 18 years she will have a nest egg

  • When you use DRIPs in a taxable account much more bookkeeping is needed to calculate the cost per share if you sell some of the DRIPed shares. This is another factor which should be taken into account before setting up a DRIP. Also when you sell you will probably have a weird number of shares so you will receive a little less for the odd shares.

  • Pat, I think DRIPS are still a great tool: here are couple reasons why.

    I built the base for my portfolio with DRIPS in the days when brokers were charging a lot more. By sending post-dated cheques to the DRIP plans, I killed two birds with one stone: distributed my meagre resources (while raising a family, buying a house and maxing out my RRSPs) over a number of companies (mostly banks and utilities) without paying commissions, and averaging my share purchase price. Even though commissions are lower now, the ability to spread meagre resources over several sectors is a great advantage. The minimum investment in many plans is $50 per quarter.

    Of course, my plans are all collapsed now, but before I closed them out, I was able to sign over one share of some of the companies to my kids to get them started and avoid the initial high registration fees. DRIPS are great tool to get young people on the road to learning how markets work and give them an opportunity to participate at the cost of postage stamps.

    They can roll them over into TFSAs when they reach a board lot in their DRIP plans if it makes sense.

    KF

  • The first consideration has to be the selection of very sound, profitable, dividend paying stocks, with a long history of growing dividends and no reductions or cut-backs for at least 10 years. This is a Value Investing approach, according to Ben Graham and Warren Buffett teaching. That reduces your field of choices considerably, but you should not get into DRIPS for the short term, in and out type of speculative investments. Next, if you can, put all these stocks into your Tax Free Savings Account,(TFSA) where the arithmetic of share counts and tax calculations are no longer a consideration. Thereby, invest for the long term and do not trade around or change these selected stocks more than once every 3 to 5 years; unless you detect a material, significant change in their business model or financial position. DRIPS give you dollar cost averaging benefits, which also reduce risk when declines in stock prices occur. Many of the best DRIPS also offer a 5% discount on shares converted from dividends, another significant plus in the long term growth formula this strategy provides.

  • Several people have commented on the loss in selling non board lots. I have not found this to be the case. Using a discount broker I notice that the sale is completed in under 2 seconds and only very rarely has there been a price difference although on some occasions the sale is split into the board lot and the balance, albeit at the same price and only one $9.99 commission is charged.
    As for the bookkeeping I merely set up an Excel spreadsheet to record the purchases. IF CRA request documentary proof this spreadsheet enables me to locate my broker statements very easily.

  • Yes they are most of my income. The Gov.
    took away the OAS because I made too much
    money in their mind. I have all my income
    in DRIP stocks.

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