The most interesting part of investing (after buying stocks) is probably looking at your portfolio grow. Combine the magic of systematic investing with compounding interest and you get some impressive results. But you can even do more with less. You can grow your portfolio in another way which will completely be free of cash flow from your wallet.
The 3rd magic ingredient to make the perfect investing magic potion is to use the dividend payouts to grow your portfolio even faster. Sorry about the catchy title, but I wanted to find an interesting way to talk about Dividend ReInvestment Plan (aka DRIP).
DRIP While You Are Building Your Portfolio
I think that using DRIP when you are building your portfolio is a very good idea. While your systematic investment plan will serve to buy new stocks, you can grow your position by reinvesting your dividend payouts within the very same shares.
The main advantage of this technique is that you can increase your dividend holdings for almost nothing (some brokers require DRIP setup fees while others offer them for free). When you are starting your portfolio, each penny saved in fees makes a significant difference.
The dividend payouts are not big enough to use this cash to buy another stock right upfront (I suggest a minimum of $1,000 per stock to begin with). So the money will be deposited in your cash account and it will be sitting there for a while earning little to no interest at all. By using a DRIP on your stock, you are able to put your dividend payouts to work the day they are disbursed.
Can I DRIP a Stock that has no or stopped his DRIP plan?
A few weeks ago, a reader (Peter) asked me this question. He was confused as the company he bought had stopped its DRIP plan. He was wondering if he could continue to DRIP this stock by another means.
The answer lies in the type of DRIP. There are 2 types: Traditional DRIP and Broker DRIP. The latter term comes from my own imagination; Questrade calls it a DPP (Dividend Purchase Plan). The traditional DRIP is initiated by the company itself and allows investors to receive shares or fraction of shares in their investing account instead of receiving the actual dividend payout.
However, if a company stops its traditional DRIP, you can also deal with your broker and have it do the same mechanical transaction for you. This means that instead of depositing your dividend payout into your cash account, the broker will use the proceeds to buy more shares of the actual stocks you own and add them to your account. Some brokers may buy fractional shares while others will only buy rounded units and deposit the rest of the money into your cash account.
The main advantage with a “Broker DRIP” is that your firm can do it with all stocks. In fact, it is only up to them to offer a list of stocks. I’ve asked Questrade and they told me that all Canadian Stocks are offered in their Dividend Purchase Plan (how cool is that?). But before running to do DRIPs everywhere, I would first call my broker to know which stocks are available and also read the following:
There are a few situations where DRIPs are not a good idea
As with anything else in the investing world, Dripping is not the solution for everybody and for everything. Here are a few situations where using a DRIP are not a good idea:
a) In an unregistered or cash account (because you have to keep track of all DRIP operations for tax purposes… it’s a pain!)
b) When you have bigger positions in 1 stock (if you have already decided to take a risk and own a bigger percentage in one stock, I doubt that you want to mess with your asset allocation by adding to this position)
c) When you are retired (instead of growing your position, you may want to use the dividend payouts as a source of income instead of generating transaction fees to sell stocks)
d) When you urgently need to buy other stocks (it may be because you want to buy a great opportunity on the market or because you need to revise your asset allocation. But sometimes you need all your cash to buy other stocks in order to build a solid portfolio).
Overall, I think that using a DRIP is another great tool in a complete investment strategy. If you are Canadian and you are looking to use a broker to buy US stocks or make DRIPs, I suggest you take a look at Questrade which offers USD RRSP account and DRIP options on all Canadian dividend paying stocks.
For further reading on DRIP, I suggest the following readings:
I’m retired and I use a broker DRIP (TD Canada Trust). It works very well.It sort of forces me to be always buying, especially during corrections. I love those large dividend payers (4 to 7%) that pay on a monthly basis and I reinvest accordingly.
I would love to use a DRIP but right now my portfolio is not big enough to buy a share of any of my holdings. I do have a mutual fund that DRIPs because it can buy fractional shares.
I am going to wait to use DRIPs until I have enough to buy a share of the stock or until I have gotten enough holdings to consider my portfolio properly allocated.
I like how DRIPs buy you more shares when the stock price is on sale. I DRIP all the stocks in my cash brokerage account. Over time the compounding effects should be quite rewarding (~_~)
Poor Student – I agree with you. My plan is to invest in value/growth stocks, and then move half my profits into index funds and drip those for the long-term. Also a poor student.
I’m a pretty new investor, What do you think about the idea of efficient markets?
Like Liquid, I DRIP everything I can. There are very few stocks I don’t DRIP.
Nice post 🙂 I know Valentine’s was yesterday, but I love dividends!
@Mike
efficient market is a great theory but was clearly destroyed during 2008-2009 :-). Canadian Banks lost more than 50% of their value within 6 months while they were posting profits!
Gotta love dividends! Reinvesting dividends in good solid companies is a sure way to beat inflation! Though I would caution DRIPs on shaky companies. If I have a short term interest, I simply take the cash.
Mike, I am not sure I buy the reason you outline for a) when it comes to corporate dividends as opposed to distribution from REIT. From a tax perspective, dividends are quite attractive in a non-registered account compared with interest and bonds due to the dividend tax treatment. Preferred shares fall into that as well. All you get is a T5 form and use that for your taxes – very simple. The share repurchased are after tax just like any income. However, distribution from REITs are a real pain for income taxes because they don’t just pay dividends, they also have return of capital and such and you have to adjust your ACB with all distribution. I would say that your point a) applies to REIT or income trusts mostly. To make it more complex, US dividends are not taxed efficiently except from within an RRSP …
Here is a standard quote about dividend investing.
“Preferred Shares and Dividend Achievers. Because of the dividend tax credit, these types of investments are typically held outside of registered accounts.”
Obviously, tax free growth in a TFSA beats everything. However, there could be arguments on the taxes you would pay in an RRSP compared with the taxes outside. For anyone, the RRSP income is a marginal tax rate where as the dividend income outside has a tax treatment.
Including a link with a discussion thread: http://www.canadianmoneyforum.com/showthread.php?t=1069
When you DRIP, you have to keep track of your Adjusted Cost Base after each transaction in a non-registered account. You don’t have to keep track of it, but it is easier to do as you go instead at tax time if you sold the stock.
When REITS and mutual funds are used you possible have return of capital but you will find this out on your T3. You just subtract the ROC from your ACB to get a new ACB. I believe if your ACB goes to 0, then your ROC is treated differently for tax purposes, such as a capital gain each year and you pay tax on it every year besides the normal capital gain(loss) when you sell. I am not 100% sure of this last statement.
Dividends from canadian corporations are taxed favorably in a non-registered account if you are Canadian.
I love reinvesting dividends. I am with Zecco for my taxable account and I was prepared to move it to another since they didn’t do partial share reinvestment. Luckily they recently completed an upgrade (or downgrade, not sure) but you can now reinvest with partial shares.
There is a new SEC requirement in 2011 (this applies for the US only) that requires the broker to track every stock purchase by assigning a tax lot number. So, going forward you really don’t need to worry about cost basis calculations for DRiPs handled through a cash or taxable account with a broker. (I don’t know if the third party transfer agents are required to do this or not – this is a good question. Third party agents can handle DRiPs without a broker).
For my part I generally don’t put stocks on automatic DRiPs. This has both hurt me and helped me. I have decided to put those stocks that are future big growers for me (once the economy turns around) on DRiP to accumulate shares faster. PAYX is my one big hitter that fits in this category.
For other stocks I accumulate dividends and make bulk purchases when prices are attractive.
I think (as I’ve learned from my post about DRIPs) that the broker drip’s official term is a “synthetic” drip.
One thing I learned is that you need to have enough shares to drip one share or else it will never drip 🙁