I have been getting a few questions on DRIPs so I thought I would create a 3-part series on them.
- Part 1 – The Basics of DRIPs (below)
- Part 2 – How to Setup a DRIP
- Part 3 – DRIPs with the best discounts
Dividends are a popular way to build an investment portfolio and dividend investing in general is growing in popularity. DRIPs are one way of reinvesting dividends and are considered a ‘slow and steady’ way to achieve wealth.
Related: 5 Advantages of Dividend Stocks
Here is a quick guide on DRIPs – including what they are, pros & cons and how to track their cost.
What is a DRIP?
A DRIP stands for Dividend Reinvestment Plan and is a method to automatically reinvest any dividends received from a publicly traded company. It is sometimes referred to as an SPP (share purchase plan). The dividends that would normally be received as cash are instead used to purchase more shares.
Using a ‘full’ DRIP or a ‘true’ DRIP, the total amount of the dividend is reinvested to buy more shares – even if it results in partial amounts of shares being bought
For example: if a dividend is $0.50/share and there are 160 shares, the dividend normally received is $80. If the current share price is $30, this means 2.67 shares would be bought automatically rather than receiving $80 in cash.
A synthetic DRIP is similar to a regular DRIP except that the dividends received must be enough to buy at least one share. These are as popular as a regular DRIP but they require more money up front to receive enough in dividends to ensure at least one share can be purchased.
If there isn’t enough for at least one share – the dividends are given as cash.
To figure out how much you need to buy to ensure you get at least one share, you would divide the current share price by the dividend.
For example: The current price of Bank of Nova Scotia (BNS) is $63.32. The quarterly dividend is $0.62. So $63.32/0.62 gives 102 shares needed to buy upfront to ensure a synthetic DRIP gives you at least one share.
It’s important to note that if the stock price rises, then more shares need to be purchased up front – otherwise the dividend will be given as cash.
Synthetic DRIPs are offered by discount brokerages such as Questrade, TD Waterhouse, BMO Investorline, and many others. With a ‘full’ DRIP, you are the registered shareholder. With a synthetic DRIP, you are the non-registered shareholder.
A DRIP has the following advantages:
- Allows for automatic reinvestment – perfect for ‘hands-off’ investors
- Lower fees involved because the dividend reinvestment is automatic. Company-operated DRIPs (‘true’ DRIPS) have no commission fees involved
- Provides dollar-cost averaging for the investor
- Provides a stable base of shareholders for a company. DRIPs take more time and effort than a regular stock, so DRIP participants are less likely to buy/sell frequently
- Easy access to capital for the company. DRIP shares are bought from the company, not on an exchange, and they are reinvested right back into the company
- They take the emotion out of investing because they are automatic
- They can be discontinued if desired and the investor will then receive cash dividends instead
- Canadians are eligible to participate in American DRIPs (as long as the company plan allows for foreign ownership, which can be confirmed on the company circular)
A DRIP also has the following disadvantages:
- not all companies that pay a regular dividend to shareholders offer a DRIP
- it can be time consuming and somewhat costly to set up a DRIP
- they are considered taxable income and taxed like regular cash dividends – even though no cash is received
- for non-registered accounts, the investor must constantly track the adjusted cost base (ACB) – which changes as more shares are acquired
- some DRIPs have minimum purchase requirements
- the investor is usually notified 1-2 weeks after the automatic share purchase has occurred (no real-time reporting)
- most brokers only offer synthetic DRIPs – which means only full shares can be purchased (not partial ones)
The other downside is that dollar-cost averaging may not be in your favor. If a stock has increased in price to a point where you’d normally sell, buying more shares (which happens automatically with a DRIP) may increase your cost base of the shares.
Assuming the stock price has increased, the dividend would buy fewer shares because the value of the shares has increased.
The opposite is true if the stock decreases in price – the dividend would buy more shares and the average cost would go down.
It all depends on the current share price when the dividend is paid.
To get around this, some companies offer a discount on the DRIP. They will give a small percentage (usually 2-5%) off what the current share price is.
A discount would lower the average cost and also means your dividends can buy more shares. Companies offer discounts to attract investors and the amount of the discount may change depending on market conditions.
Which Companies Offer the Best Discounts?
Stay tuned to read Part 3 of the guide: which Canadian companies currently offer the best discounts on their DRIPs.
How Can I Track My Cost of Shares?
Click here for an example spreadsheet used to track the ACB (adjusted cost base) of shares that are under a DRIP.
Related: How to Fix Tax Return Errors
How Do I Setup a DRIP?
Stay tuned to read Part 2 of the guide: how to setup a DRIP in 4 simple steps
Deciding whether to use a DRIP or synthetic DRIP is a personal decision and would make the most sense for someone who is hands-off on their investments or doesn’t have time to follow them carefully.
There are advantages and disadvantages of a DRIP that need to be considered before deciding whether to use one.
Personally, I don’t use DRIPs because they don’t take into account valuations – when stocks are high I am more inclined to either sell (rarely), or hang on and buy more when they go lower. When prices are low I prefer to buy more, and receiving dividends in cash allows me to determine when to buy or sell.
Does anyone use DRIPs? If so, how has it worked and would you recommend it for anyone considering it?
Note – for even more detailed information on DRIPs be sure to visit Drip Primer – the main source of information for everything DRIP-related. Also check out the guide created by My Own Advisor & Dividend Ninja