This is the fourth of a six-part course on advanced investing that we publish every week.
In my last article, I discussed the many benefits of dividends. This time, I want to take the discussion a step further and talk about one of the dividend investor's biggest allies – the DRIP.
No, not Chinese water torture. DRIP stands for dividend reinvestment plan, and it's one of the best ways to cut your investing expenses and maximize the benefits of compounding. DRIPs allow you to reinvest your dividends in more shares of the same company – automatically and with no commissions – so more of your money will be working for you.
The Internet is teeming with websites devoted to DRIPping, a popular hobby for do-it-yourself investors. For some helpful background material and a list of Canadian companies offering DRIPs, check out this page or this blog.
There are different types of DRIPs, each with advantages and disadvantages.
Discount and full-service brokers offer “synthetic” DRIPs, which are the easiest to set up and manage. Simply call your broker and ask to have your securities enrolled in the DRIP plan. Not all of your stocks may qualify; you can obtain a list of eligible stocks from your broker.
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Learn more about investing from John Heinzl The 2010 Investor Education series for beginner investors: |
The main drawback of synthetic DRIPs is that your dividends will only be reinvested in whole shares. For instance, if you receive a $50 dividend, and the stock is trading for $40, you'll be credited one share and receive the remaining $10 in cash. Another drawback is that some brokers don’t allow you to pick and choose which securities to enroll in a DRIP - it’s an all-or-none decision. But most - including BMO InvestorLine and TD Waterhouse - do allow you to choose. Check with your broker for their DRIP policy.
Most mutual funds also allow you to reinvest distributions automatically (be sure to notify your broker if you want the reinvestment option). The downside of mutual funds are the high fees.
Setting up a “true” DRIP takes a bit more work. First, you have to buy at least one share of the company. Then you must register the shares in your name, which usually involves taking physical delivery of the certificate. (Your broker will charge a fee for this service. BMO InvestorLine, for instance, charges $50 plus GST). Then you have to contact the company's transfer agent – the firm that keeps track of shareholder records, including DRIPs – and enroll your shares in the plan.
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More about DRIPs:
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The hassles and expense of setting up a traditional DRIP turn some investors off. But hardcore DRIP enthusiasts say it's the best way to go, because these plans usually permit the purchase of fractional shares, so all of your dividends will be recycled into more stock of the company.
Why do companies offer DRIPs? Simple: It allows them to cut their financing costs. Instead of sending out a cheque to shareholders, they simply issue more shares from their treasury.
Some companies are so eager to sign you up for their DRIPs that they offer a discount on shares purchased through their plans: DRIPs drop discounted shares in your lap.
Things change frequently in DRIP-land, so if you're thinking about enrolling in a DRIP, be sure to check with the companies themselves to verify any details. You can also call or visit the websites of the two largest transfer agents, Computershare and CIBC Mellon, for more information.
Setting up a DRIP is a bit of a pain. But watching your dividends compound over time is all pleasure.
Editor's Note: In an earlier verison of this story, the sixth paragraph contained incorrect information saying brokers do not allow clients to choose securities in a synthetic DRIP. It has been corrected.
