Being a nosy fellow, in last week’s Investor Clinic video I asked people what they do with their dividends. Based on this highly unscientific survey, I offer the following two observations:
1. Some people have given this A LOT of thought.
2. Not everyone is sold on the benefits of dividend reinvestment plans, or DRIPS.
As some readers pointed out, DRIPs have several drawbacks. There are costs to buy the shares and register them in your name (unless you buy a share from someone privately, which entails some extra work and risk). There’s also paperwork involved to track your adjusted cost base, which changes every time you reinvest a dividend.
With broker-operated DRIPs, in particular, another drawback is that in most cases you can only purchase whole shares, so any cash left over sits in your account gathering dust. One reader was also frustrated because there was a delay of up to two weeks before some dividend purchases were recorded in his account.
Here’s what Jay, a Montrealer who now lives in Japan, said about his experience with a broker-operated DRIP:
“I was involved in a DRIP for about two years until earlier this year. I stopped it [because] … I didn't have any control over the price I paid for the stock. Dividends are sometimes paid on days when the market soars, and you end up buying at a near-term high.”
“Now, I simply let the cash accumulate while keeping my eye on the markets through a watch list of 50 or so stocks. The recent downturn offered some good opportunities to buy at very attractive prices. I much prefer ‘strategic strikes’ of stocks that are attractively priced and fit in with my sector allocation plans rather than broad reinvestment of the entire portfolio. It’s like a rifle as opposed to a shotgun approach.”
Another strategy is to use dividend income from a non-registered account to fund annual contributions to registered retirement savings plans, registered education savings plans and tax-free savings accounts.
“Most (about 90 per cent) of my dividends are from Canadian corporations and these stocks are in non-registered accounts. I allow them to accumulate and then transfer the cash to my RRSP, my spousal RRSP, our RESP and our TFSAs,” said Stuart from Quebec.
“Once in the RRSPs I invest them in fixed-income (strip bonds or exchange-traded funds) or foreign equity according to a predetermined total portfolio allocation. Once in the family RESP I invest in guaranteed investment certificates or keep it in cash, as one of my children has begun postsecondary education and the other two will follow in the next five years.”
For the TFSA, Stuart invests in a no-load mortgage mutual fund, which offers liquidity, a modest yield and low volatility.
“In other words, our ongoing needs in RRSP, RESP and TFSA are self-financed by dividends. Not only do I get the dividend tax credit but I also get the income tax refund with respect to the RRSP.”
Of course, not everyone has the luxury of re-investing their dividends. Robert of Victoria sold his business in 2007 and put most of the proceeds into the stock market. He now lives off dividends from his portfolio of U.S. and Canadian blue-chip stocks.
“I buy into the strategy of dividend payers with a history of regularly raising their payouts and it seems to help push [up] their asset value as well. I feel it is only a matter of time before Canadian banks start to raise dividends again and they have been remarkably good long-term holds in spite of the Great Recession and general chaos.”
Robert also offered this piece of advice, which is worth sharing:
“Having lived the life of a student and poor struggling young businessman I have no problem living on less and actually think it might be kind of a fun challenge (although I refuse to stop travelling and buying guitars). The key is no debt. Pay off the mortgage while rates are low. Do not be tempted by low rates and run up a huge line of credit. You do have to pay that money back regardless of the rate. Fear debt like the bubonic plague and get rid of it ASAP.”
Thanks to all who shared their stories.
