To DRIP or Not To DRIP

Dividend Reinvestment plans (DRIPs) are investment programs run by publicly traded companies to invest in them and provide shareholders with partial shares reinvested back in the company instead of paying out cash dividend each quarter (or whatever the dividend schedule is). This is advantageous to the companies since they can keep the money in the company where it can be put to good use while providing investors in more stake of the company through the share reserve. Companies usually run these programs through a Transfer Agent or a Brokerage firm. This article takes a look at the overview of the DRIP program and the various advantages and disadvantages to investors using this methodology.
When investing via DRIP, there are couple of terms used liberally and I want to include them here as I use them in the article below. A Share Purchase Plan (SPP) allows you to buy more shares in the company in the future.  This is usually a recurring event that you setup with the Transfer Agent or Broker. An Optional Cash Purchase (OCP) is a one-time optional purchase of more shares in the company. 
The following are the advantages and disadvantages of the DRIP program.

Advantages of DRIP

  1. Commission-free: Enrolling in the DRIP program does not cost the investor any money. The program is sponsored by the company and so, there are no brokerage fees or transaction fees to worry about.
  2. Partial shares: Investors can choose a certain dollar amount to contribute by enrolling in the SPP or using the OCP to buy partial shares in the company. When dividends are scheduled, partial shares from the reserve are allocated instead of distributing the dollar amount.
  3. Faster Reinvestment: This point is best illustrated by comparing synthetic and full DRIP. Synthetic DRIP is the DRIP supported by most discount brokers, where the dividend amount needs to cover a whole share. Full DRIPs, on the other hand, work with partial shares as well. The advantage of Full DRIP is that money gets reinvested immediately, even with partial shares, and investor’s money can be put to work effective immediately.
  4. Discounts: Some companies provide discounts for registering in the DRIP program. These discounts can vary anywhere between 1-5%, which means higher dividend rate and yield-on-cost on your overall returns.
  5. Dollar Cost Averaging: Enrolling in SPP or using OCP offers investors with the opportunity of taking advantage of dollar cost averaging. This is one of the cornerstones of long term investing and you are able to build your equity slowly.

Disadvantages of DRIP

  1. Setup Effort: Setting up the program and getting started takes a lot of time and effort. Also, getting your first share and setting up is confusing for starters which deters people from enrolling in these programs.
  2. No Control on Stock Price: Due to the way the payment structures are setup with SPP  or OCP, the investor can only choose the amount of money invested and has no control of the price paid on the stock. The Transfer Agent or Broker simply takes the closing market price of the stock on the date it chooses to execute the plan.
  3. Where’s the money? If you depend on and need to withdraw income from your investments, DRIP programs do not work out, as you don’t actually see the money. All you get is more equity in the company.
  4. Taxation: Although listed as an advantage by a lot of writers (due to dividends being taxed favorably), taxation can be a double-edged sword. I consider taxation more of a disadvantage than an advantage due to the fact that there is no tax-shelter when investing using a DRIP program. Consider all the taxation involved when investing via DRIP – (a) the companies pay out their dividends after it has paid its due taxes, (b) you are investing in the company after paying your income taxes, (c) you pay taxes on the dividends received, and (d) you pay taxes on the capital gains. If the money was invested in registered accounts instead, you would be sheltered from some of the taxes mentioned earlier.
The taxation point is a big thorn for me personally. Even though I have a DRIP account with one company – The Bank of Nova Scotia (BNS), I am not convinced that DRIP programs are that great. Do you think there is any value in DRIPping outside tax-sheltered accounts (even with the DRIP discounts)?
To learn more about DRIPs, go to DRIP Primer and DRIP Investing.
Disclosure: I am long BNS. See my full list of holdings here.

21 thoughts on “To DRIP or Not To DRIP

  1. Great topic my friend. Some DRIPs are clear cut winners. I’ve been very happy with most of the ones I own. A few of them raised their fees sky high following the financial crisis. I’ve never actually owned a company that had a DRIP discount, but that always seemed interesting.
    My plan, and it’s worked well, was to invest in 10 different DRIPs in late 2008…..and let the dividends reinvest. Last year, with the huge run the stock market had (and my unemployment), I received the dividends by check. If the market drops, I will start reinvesting the dividends again. Either way, there is almost no fee to reinvest or receive a dividend check. I think the most expensive one I have…..costs me $0.60. The only significant cost is when you want to sell your shares. In order to discourage buying and selling, it cost me $60 to sell my position in ADM last year. Still, that’s not bad considering 6 years of free reinvestment.
    -Bryan

    • Thanks for stopping by and the comment, Bryan.
      I didnt realize that you had to pay a fee to sell. I just started with the DRIPs in BNS last year and dont really intend to sell and trade them regularly. I am, however, looking forward to seeing my investment compound over the next few years. They finally started a pre-authorized deposit, so I dont have to send in a cheque every time I had to do an OCP.

      The discounts for signing up with DRIP is the biggest attraction for me – which raises my YOCs. Without that discount, I dont see any big advantages, esp considering that trading fees are so low these days.

      regards
      R2R

    • I hear your concerns R2R, but DRIPs have two really BIG redeeming qualities. 1.) For people who are prone to trade a lot, they will discourage you from doing so. And if you hold a company for 10 years (assuming it’s a good investment) your fees will be almost nonexistent….even with the sales charge.
      2) For people working with small amounts of money…..and wanting to put $1500 for instance, into a several small investments…..the costs are lower than a brokerage and they encourage partial share reinvestment. You could never afford to reinvest your money and buy half a share of coke (for instance) with a $7 commission. The commission would constitute more than 30% of your reinvestment amount.

      I don’t trade in them, but for long term taxable holdings, I’ve been very happy with my DRIP accounts.
      -Bryan

    • Agreed that DRIPs are great for long term investing while keeping the investor’s impulses to sell in check. Also agree completely that one can put in a small amount to buy partial shares and great for building up equity.

      regards

  2. R2R,
    I asked myself that question a lot. DRIPs are good for great companies when the fees are low or non-existent. I own have a number of them. Dividend reinvestment I believe is the best advantage of them. You can easily put the money back in. The longer you hold them the better. I’ve owned CVX, KO, VZ and BAC all for more than 10 years in DRIPs and those are all winners. But I owned one for another company that went sour and I wish I hadn’t reinvested the divs. Now I’m thinking about stopping the reinvestment on some of those holdings and putting them into another account. Work in progress as always. Good post.
    -RBD

    • Thanks for the input, Retire Before Dad.
      The lack of tax shelter is what is causing me to question this as I can use a TFSA account (the US equivalent would be IRA, I believe?) where I pay $5 for a trade and all subsequent dividends, capital gains are tax-free. The big advantages are of course the partial shares and the discounts.

      What is making you stop your reinvestment on some of the holdings?

      Best wishes
      R2R

  3. Yesterday I received a message from my bank.
    I can choose at SSE if I would like to receive a “stock dividend” or Cash.
    The same some weeks ago at RDS.

    At the moment I decide me every time for the cash-dividend.
    If you have earned more than 1.602 EUR until now, the better choice is “stock dividend”. Than you don´t have to pay tax…

    regards
    D-S

  4. Anonymous says:

    Hi Roadmap,
    I wanted to point out that there is a fallacy in your tax disadvantage comment. If you DRIP in a tax sheltered account such as an RRSP, when you withdraw the funds you will be taxed as if your withdrawals are earnings – meaning fully taxed. You will NOT get the benefit of a dividend tax credit or lower capital gains tax as you would in a non-registered account. Both dividends and capital gains are taxed at lower rates than regular income such as RRSP withdrawals. So, yes – you might save tax now but you might also pay even more later. Beware!

    Regards,
    MG

    • MG,
      You are right that you eventually get dinged by the government when you withdraw the money from your RRSP and dont get the dividend credit that you could have gotten. But there are no such pitfalls with TFSAs. No taxes on dividends and no taxes on capital gains, which makes it a much better vehicle to use than either RRSP or taxable account.

      Thanks for stopping by and the comment.

      regards
      R2R

  5. Roadmap – I have to say I have never really been able to make my mind up on this one, and as result have taken a bit of a hybrid approach.

    I tend to want to have the cash to make purchases of companies that I think are attractively valued. This is primarily the tactic I employ.

    However, I will DRIP companies that provide what I consider to be an attractive discount. For me that is at least 3% or more. No magic to that number, just something that I feel is a reasonable discount and enough to entice me to DRIP the stock.

    Currently I have 35 positions, and I am DRIPing seven of those. Five of these seven offer a 5% discount, the other two are provide a 3% discount.

    Take care.

    • I am on a similar boat where I have never really been able to make up my mind. I just have one DRIP plan with BNS. The discount is the only big selling point for me. Most of the Canadian companies which have a SPP and offer discounts are companies which I do not want to invest in. BNS and ENB are probably the only ones that I would consider investing in that offer discounts.

      Thanks for stopping by and the input.

      regards

  6. Anonymous says:

    When I first heard of DRIPs a couple of years ago, I setup about 10 of them and assumed I’d be focusing on them heavily. But my experience with DRIPs has been somewhat negative, and I’ve found a modified synthetic DRIP approach using my normal discount brokerage accounts to be preferable.

    The things I don’t like about my DRIPs:
    1. Barely functional websites
    2. Glacial transaction times – it can take months for me to get a stock purchase done
    3. Did I mention the terrible websites? Each one has its own unique set of shortcomings

    My modified synthetic approach is just to let the dividends accumulate in my brokerage account, and buy whichever stock I prefer when the cash balance gets over $1,000. If I were starting again now, I wouldn’t bother with DRIPs at all.

    JT

    • JT,
      I hear ya. The website from Computershare transfer agent isnt anything fancy, but i dont really expect much from them.
      But the transaction times are extremely annoying. It took me months to get up and running. Anything related to investing where time/timing is everything, it shouldnt take months to set stuff up. They need to realize that its not the 18th century.

      Overall, I am not crazy about the DRIP approach and will be using synthetic drip for most of my investments.

      Thanks for stopping by and sharing your experience.

      regards

  7. Roadmap2Retire

    I do see a lot of value in the DRIP. I DRIP nearly every stock in my protfolio right now. A lot of the stocks that made a lot of money for people made even more if you would have reinvested the dividends over the years if you look at the investment calculators.

    I do see the point of a high price can hurt you in the long run too, but I like being able to increase my dividends month after month or quarter after quarter without paying any fees or commission.

    • Dividend Swan,
      DRIP provides a great way to build up a portfolio by investing a small amount every month and I am a big fan of dollar cost averaging. If my brokerage didnt have significant trading fee (even though its quite low at $4.95 per trade) I would use the same method. I just let the dividends collect for a couple of months and reinvest manually.

      Thanks for the comment and sharing.

      regards

  8. Anonymous says:

    However, I will DRIP companies that provide what I consider to be an attractive discount. For me that is at least 3% or more. No magic to that number, just something that I feel is a reasonable discount and enough to entice me to DRIP the stock.

    Currently I have 35 positions, and I am DRIPing seven of those. Five of these seven offer a 5% discount, the other two are provide a 3% discount.

    I copied the above post so as it was eaiser to ask the question how much do you save per year by using these discounts? I have a fairly large portfolio and these discounts and fractional shares add very little value.

    • Those are some good discounts, Anon. My DRIP with BNS has terminated the 2% discounts that they offered starting last month. That was a huge selling point point for me to DRIP and now that its gone, I am reconsidering the whole idea. I would probably be better off moving the stock into a TFSA (capital gains are dividends are tax free) account. I will be losing the DCA ability, but might be worth it.

      Those are some great discounts you have there. Which stocks do you own, if I may ask? I havent looked at the US stocks, but most of the Canadian stocks that offer discounts arent the greatest companies which I would normally invest in.

      Thanks for stopping by.
      R2R

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