Thursday, November 8, 2007

to DRIP or not to DRIP

A Dividend Reinvestment Plan or (DRIP) is a service that you can set up with a company, with which you own stock, where the dividends paid by the company are automatically used to purchase additional shares of the company's stock. Therefore, you will never actually receive the dividends in cash; instead they will be used to buy more of the company's stock. Among the several stock investors that I know, there seems to be a dichotomy of opinion on whether or not a DRIP is a useful tool for a long term investor. It is important to note the DRIPs vary by company as to how their plan works, and not all DRIPs are free of fees. Not all DRIPs are created equal! In Canada there are two main companies that administer DRIPs for Canadian corporations. These companies, which are called transfer agents are Computershare and CIBC Mellon

I currently have 4 of the 15 stocks that I own enrolled in a DRIP plan. These 4 DRIP'd stocks are:

Johnson & Johnson (JNJ) - Computershare
Royal Bank of Canada (RY) - Computershare
Telus (T.A) - Computershare - Share Purch. (SPP) as well. - Best DRIP
Manulife (MFC) - CIBC Mellon - small fee ass. with DRIP - Worst DRIP

These are all companies that I plan to hold for the long term (ie at least 15 - 20 years).

Reasons I like, & ADVANTAGES of using a DRIP:
- Usually FREE of charge - this eliminates the trading fees that you would normally encounter when adding to current stock positions

- Great tool to employ the magic of COMPOUNDING. Dividends buy more shares which in turn produce more dividends. Fractional shares (ie 1/10) of a share, still produces a dividend.

- NO HASSLE. DRIPs will continue to operate without you lifting a finger. Your stocks will still reproduce while you sipping a Pino Colada on a 4 week all inclusive vacation in the Mayan Riviera.

Reasons I don't like, & DISADVANTAGES of using a DRIP:
- Once a DRIP has been set up, your capacity to buy stocks when they are cheap is diminished. You do LOSE the ability to add to a position on a down day, or buy on a dip.

- Some DRIPs do not include a Share Purchase Plan (SPP). In these cases this means once you are locked into a DRIP you CAN NOT ADD to this position.

- A limitation of a DRIP for a smart investor is that you must be completely sure of your long term confidence in the company. If you select a company to DRIP, this is a COMMITMENT to this company for the long term as your investment is more difficult to access quickly, and the whole point of a DRIP is to let it ride long term.

Overall I am on the fence with respect to DRIPs. There are certainly advantages and disadvantages as I've indicated above, and much of the decision of whether or not to DRIP is up to one's individual investment style and goals.

It is important to note that there is another form of a DRIP available which is called a 'SYNTHETIC DRIP'. A synthetic drip can be set up directly with some discount brokers. This type of DRIP works the same way as a conventional DRIP except for the fact that a synthetic DRIP will not purchase fractional shares. For example if a stock is trading at $20 and your quarterly dividend amounts to $19, the DRIP will not buy anything. If your quarterly dividend amounts to $39, the DRIP will only buy 1 share, and will leave $19 cash in your account. This is a disadvantage, as you do not get your entire dividend amount re-invested, however an advantage of a synthetic drip is that the company shares are still with your broker so you can add to them anytime (on dips etc.). I have not yet set up any synthetic drips, however I do think these are attractive and I may set them up in the future for some holdings.

If anyone has any experience with Synthetic DRIPs, and would like to provide some feedback on how they work with certain brokers please comment.

13 comments:

Traciatim said...

If you like DRIPs another option is to use ShareOner Investments. It's a co-op trading service that will auto-buy your dividends, can use fractional shares, and only costs 9 bucks a trade (lower if you lump all of your trades in one transaction).

They have a pre-screened list of securities, which I feel is their only major drawback.

I signed up with them when I was first thinking about investing thinking it would be a great place to learn, but now I realize I would prefer the control of a full discount broker.

Still, owrth a check out if you like DRIPing or just simple investing.

telly said...

My 401k account (through Schwab) provides the option of DRIPs (fractional shares) for at least 2 stocks that I own (JNJ & C) as well as for ETFs without fees.

I DRIP everything as the dividend recieved from my small holdings in each stock is very small compared to my regular contributions. The dividends paid alone would take too long to accumulate to buy enough shares to justify the commission paid.

WhereDoesAllMyMoneyGo.com said...

Someone asked me about a list of all DRIP's and SPP's and I found a good source here:

DRIPs

SPPs

If those tags don't work:
http://www.ndir.com/SI/DRPs/DRPs.shtml
http://www.ndir.com/SI/DRPs/SPPs.shtml

FourPillars said...

Really good look at DRIPs. Personally I think they are a good tool to consider especially if you are looking for convenience. And if they don't fit your criteria? You don't have to use them.

I would argue that compounding is not related to DRIPs though. As long as you reinvest the dividends in equities then you will still get the compounding effect..

I use a drip for VTI and VEA which I have in my rrsp - the reason I do this is to keep the money in US$ otherwise they get converted to CDN$ cash.

Mike

MG said...

thanks for the comments.

4P, Compouding is accelerated when you are involved in a drip because your get your shares bought usually fee-free, hence you have more buying power so you buy more shares.

FourPillars said...

Good point - I forgot about the free purchase.

Mike

FinancialJungle said...

Hmm... never been a big fan of DRIP. One reason is I'd have to track the ACB. Another is, being a value/dividend investor, I'm constantly looking to buy the best bargain, instead of automatically accumulating at whatever the market price happens to be.

On the other hand, I'd consider DRIP for companies that offer 3% or 5% discount.

MG said...

FJ, Tracking the ACB is easy once you have it set up. I agree with you somewhat, but I do think DRIPing has value due to the fee-free, automatic nature of the investment.

pitz said...

I've looked at the efficacy of DRIPs, but the time you build a reasonably diversified portfolio with maybe 2 dozen names, and go through all the motions and hassle, a $120/year (minimum commission) Interactive Brokers account seems to be a logical alternative.

Here's my logic:
Making 24 DRIP purchases a month would cost you roughly $24 in stamps and envelopes. The foreign exchange to buy those DRIPs, at $5000/year invested would be another $60/year. And of course, some stocks have DRIP fees.

Add it all up, and DRIPs to periodically buy shares, IMHO, just don't make sense if you can use an Interactive Brokers account. Especially since the balance of the minimum monthly commission is tax deductible.

Plus having the margin facility available can help you out with other short-term financial goals, ie: if you come up short one month on expenses, you can borrow cheaply on margin. Can't do that with shares stuck in a DRIP.

pitz said...

Also....with the way mortgage rates are going these days due to the loss of confidence in MBS, it might soon be cheaper to borrow on margin (with MTM'ed collateral) to fulfill your funding requirements instead of relying so heavily on housing secured debt.

For someone in debt, keeping your potential sources of funding as diversified as possible is a good idea.

ScottK said...

I own General Electric through a DRIP. It works out really well. Dividend reinvestments are free while stock purchase has a commission of only $1. In fact, I just wrote a little post about it on my blog: http://www.illiteratewithdrawal.com/2007/11/general-electric-drip/

Jda said...

Pitz:

There are only two transfer agents in Canada: computershare & cibc mellon so it's not likely you'll spend $24 on postage each month. For the U.S. transfer agents, you can buy shares online through US online banking which eliminates the postage all together.

Anonymous said...

About synthetic DRIPs: We have an account with BMO Investorline, building up a portfolio one stock at a time, with the dividend reinvestment option specified where applicable. One advantage of this arrangement: it gives us a target to aim for when considering ‘how many shares should we purchase?’ The answer – enough for each dividend payment to purchase an additional share (with the target price roughly padded to reflect possible future short-term rises in the share price.) If the share price is low enough, we try for enough shares to purchase 2 or more shares per dividend.