The pros and cons of dividend reinvestment plans
Readers of this site will know I take a hybrid approach to investing.
I invest in a number of Canadian dividend paying stocks for long-term growth and income, and I use synthetic dividend reinvestment plans (affectionately known as “DRIPs”) to accelerate that growth. This chart is an example of some of that power:
I also invest in some low-cost Exchange Traded Funds (ETFs) for U.S. and international diversification.
I arrived at this two-pronged investing approach, rightly or wrongly, because I feel our Canadian market is not very diversified – so it becomes easier to replicate said market in a Do-It-Yourself (DIY) stock portfolio for what the big funds in Canada own – and pay no ongoing money management fee to do so.
Why not dividends
While dividend investing makes up a very big part of my investing approach, including the stocks that pay dividends in my portfolio, dividends aren’t the be-all, end-all for investors for a few reasons:
- The trouble with any “live off the dividends approach” is that you’d need to save/invest too much to generate your desired income. For example, it might take a $1 M portfolio to “safely” generate ~ $40,000 per year in dividends without touching the capital.
- Whether you’re living off dividends or capital gains – it’s the same difference really. $1 earned (whether it’s from dividends or capital gains) is still $1 earned. Dividends are therefore part of an investor’s total return.
- Stock picking (including selecting dividend paying stocks to buy and hold) is fraught with under performance of the index long-term.
- You can never possibly know long-term how dividends may or may not be paid by any company.
- And more and more and more…
As mentioned a few times on this site, in many respects, these investors are not wrong.
- You do need a bunch of capital to generate healthy income if you’re not selling stocks and relying on cash flow.
- Dividends are just one element of total return.
- Stock picking can deliver market under performance.
The ability to live off dividends (and I should add distributions from our low-cost ETFs) will be beneficial for reasons beyond the risks above. It has these benefits:
- Given future unknowns – having ample capital for our financial future will give us many options.
- I’m conservative as an investor – so living off dividends and distributions aligns with my behaviour and investing approach.
- I find dividend income easy to track – it’s tangible money I can spend without little fear or stock market risk.
To DRIP or Not to DRIP – that is the question!
At some point on your investing journey, you might consider running one or more dividend reinvestment plans (DRIPs) for one of your holdings or at the very least, you might want to know what the heck a DRIP is.
Well, you found the right blog to help you out!!
From that series and articles on that page, you already know that these plans can be synthetic (i.e., set up and maintained by your discount brokerage for you) or full with share purchase plans, to take advantage of fractional share purchases with stock transfer agents.
Based on this reader question of late, I thought I would review the pros and cons of dividend reinvestment plans including what I’ve experienced.
(Adapted reader email):
Love the site! I was wondering what you thought of the Enbridge suspension of their DRIPs? Do you see this as part of the downside with DRIPping or dividend stocks? Does your brokerage still honour the synthetic DRIP for Enbridge?
Thanks for your email and your readership.
Well, I don’t have many thoughts on suspended DRIPs per se other than such companies are obviously trying to streamline their investor relations activities and retain equity. More on that in a bit…
You’re probably aware there are a number of benefits that come with DRIPs. Here are just some of my favourites:
- There are no commissions
When you sign up for a full DRIP, with stock transfer agents, your cheques or preauthorized withdrawals are used to purchase fractional shares commission-free. This is a HUGE benefit to keeping your investing costs low, something I’m a huge advocate of.
- Dollar-Cost Averaging
The nature of DRIPs (synthetic or full) is that your money can be invested (and reinvested) over time automatically. So, regardless of what Mr. Market says about your stocks on any given day (up or down), by participating in a DRIP you’re taking advantage of all types of prices to average out your purchase price over time. I believe doing so helps take the emotions out of investing which should help you build wealth over time.
- The power of compounding in action
Money that makes money can make more money. By enrolling your stock (or ETF) in a DRIP, you get your money working for you with the compounding power that is fractional shares (full DRIP) or whole shares (synthetic DRIP). Here is a quick example to demonstrate the power:
Over a month of investing, would you rather be paid just a measly penny (I know they don’t exist anymore but….) on Day 1, but that money doubles every day throughout the month for 30 days OR would you rather be paid a fat $100,000 per day, every day, for the entire 30-day month?
There is no question what I would choose!!!
I would take the penny that doubles every day.
(Fact: $0.01 per day, that doubles in value every day for 30 days = $0.01 on Day 1; = $0.01 x 2 * 29th power for 30 Days = $5,368,709.12.
Compare that to $100,000 paid every day for 30 days = $3,000,000.) I’ll take the $5.3 million thanks 🙂
There are of course downsizes to DRIPs:
- With full DRIPs (with Share Purchase Plans (SPPs)) – you can’t control the price or timing of the dividend reinvestment purchase, the company transfer agent is in control of transactions. This means some investors may claim you are not being strategic; buying more shares when the stock price could be lower. That is a valid point but then again, dollar-cost-averaging helps take the emotions out of investing.
- Setting up a full DRIP and SPP can be some work. Just being honest here and I’ve lived that dream.
- To set up a full DRIP with SPP, there are always costs in getting that first share, from someone or somewhere including your discount brokerage to get the share “certificated”.
- You need some accounting skills to keep track of your adjusted cost base in a taxable account; especially when you sell your stocks to calculate capital gains.
- Some full DRIPs with SPPs have minimum purchase requirements; some are $100 or more.
Again, you can find many more details about setting up a DRIP, how to get started DRIPping stocks with just 1 (one) share, closing your DRIPs and SPPs and moving investments to your discount brokerage account, and more here.
What do I make of the Enbridge DRIP suspension? Does my brokerage still honour the synthetic DRIP for Enbridge?
My answers are “Meh” and “Yes”.
“Meh” – it’s fine – because Enbridge is just one of many Canadian companies that have killed or suspended their DRIP in recent quarters. I recall other big companies like Canadian Utilities, RioCan REIT, and H&R REIT did as well. More are likely on the way.
While pausing or shelving a DRIP potentially hurts small-time investors who just want to get started with dividend stock investing for a very low fee, they may hurt companies too – something you don’t want as a shareholder. Company DRIPs will increase the number of shares outstanding; diluting shareholder value. This puts unnecessary pressure on the stock price. There are also company costs associated to run the program.
As one CEO put it in a Globe and Mail article I read on this subject:
“It was kind of hard to justify that we were going to give our equity away so cheaply,” said Michael Zakuta, president and chief executive officer of Fredericton-based Plaza Retail REIT (PLZ.UN), which suspended its DRIP recently.
Companies may have a DRIP to raise equity. They may also have a DRIP because it’s company policy to do so; part of their broader shareholder management plan. Dividends and DRIPs that go with them, are just one way companies can attract investors.
When Enbridge killed its DRIP, I was still able to reinvest all whole shares earned commission-free with my discount brokerage. The same is actually true for many discount brokerages for many stocks. Turning “ON” or “OFF” a synthetic DRIP (for a company or an ETF) is usually as simple as a phone call to that brokerage and giving them instructions for the company or the account that holds your stocks, ETFs, and bonds as a whole. As you well know by now, conversely, some brokerages might take the affected stocks no longer offering a DRIP off their own synthetic DRIP list – since not all brokerages are created equal.
At the end of the day, dividend investing let alone using dividend reinvestment plans (DRIPs) is a personal investing decision. There is no right or wrong and such an approach has risks.
Full DRIPs with SPPs provide an opportunity for investors to build long-term wealth without major commission costs to do so. Synthetic DRIPs allow investors to set and forget their dividends and take advantage of the power of compounding by treating their stock in a total return manner.
I hope this post provided some insight into the pros and cons of dividend reinvestment plans to help you make an informed decision.
Got a question for me? Send it my way and leave your thoughts in the comments below. I read every one!
Happy investing – Mark