If you're a believer in the slow and steady approach to investing, dividend-reinvestment plans offer a cost-effective, long-term strategy for building your portfolio. Known as DRIPs, these plans are simple in principle: once you have enrolled in a plan, the dividends paid by the issuer are used to purchase additional shares of the same security, instead of accumulating as cash in your account.
The upfront benefits are easy to see: your portfolio grows automatically and you avoid paying the commission costs that normally apply to additional share purchases. Also, because your distributions go toward small, regular purchases, your overall price for the stock tends to get smoothed out and you get the potential benefits of dollar-cost-averaging.
To set up a DRIP, you may choose to enrol directly with the issuing company, or you could have your broker implement the DRIP in your investment account. While all these types of arrangements follow the same general process, how you set up your plan could have a significant impact on your long-term results.
Both online and full-service brokers will handle DRIPs on behalf of their clients, usually with no fees or commissions. It's simple to add a dividend-reinvestment feature to an eligible security in any of your accounts, although the securities that are eligible for dividend-reinvestment plans vary by broker.
Online brokers, for instance, offer DRIPs on hundreds of Canadian and U.S. stocks. As well, many providers of exchange-traded funds, including Horizons and BMO, offer DRIPs. A relatively recent addition is ETF market leader BlackRock Canada, which announced in 2012 that all iShares ETFs listed on the Toronto Stock Exchange would be eligible for its dividend-reinvestment plan.
Doing it yourself requires considerably more effort than setting up a DRIP in your brokerage account. To arrange a DRIP directly with the stock issuer, you would have to acquire at least one share of the stock, have the share or shares registered in your name, and then enrol in the plan by completing the required forms and submitting them to the company's transfer agent. (Transfer agents are appointed by public companies to handle shareholder transactions on the company's behalf.) Bear in mind that there are fees associated with both the stock purchase and the registration and issuance of the share certificate in your name.
However, going directly with a company-sponsored DRIP has some important advantages. Most notably, DRIPs set up directly with the issuer give you the ability to reinvest the entire amount of your dividend, even when it means being credited with partial shares. By contrast, in most broker DRIPs, the distributions must be large enough to purchase whole shares. Any leftover distributions are allocated as cash to the client's account.
An exception is the online brokerage ShareOwner, a company that's been around since 1987. According to ShareOwner's president and CEO, Bruce Seago, the firm is geared largely to long-term, non-active investors. "They recognize they're going to be investing for many years," says Seago. "They want to be able to buy good companies or be investing in the index, and just have those investments essentially roll over every year and grow without a lot of maintenance on their part." Seago, a veteran of the online trading business, purchased ShareOwner from founder John Bart about a year ago.
As the company states on its website, ShareOwner is the only investment dealer in Canada providing automatic reinvestment of dividends to four decimal places. According to a long-time client who we'll call Alex, the "loose change" that doesn't get reinvested by other brokerages can make a huge difference.
"You may not think it adds up to much but it does if you're looking over a period of years and decades -- which you are if you let these dividend-reinvestment plans work properly," he says. A recently retired lawyer, Alex has been investing with ShareOwner since the early 1990s and says he regrets not starting dividend reinvestment even earlier in his investing life.
ShareOwner's ability to provide this service is based largely on making scheduled group purchases. With this strategy, the brokerage pools the dividends received by its clients to purchase additional shares of the stock. Then it allocates these new shares to the appropriate clients. (ShareOwner does charge commission on purchases made outside of its schedule. One such situation would be when a client perceives, and wants to take advantage of, an immediate buying opportunity, says Seago.)
Nonetheless, whether you participate in a DRIP administered by ShareOwner or by another brokerage, you may be foregoing one important benefit -- the potential to buy shares at a slight discount to the market.
While brokers usually purchase new shares for their DRIP clients on the open market, investors who enrol directly with the company may get a slight discount on the share price. For example, shares for Toronto-Dominion Bank's TD dividend-reinvestment plans may be discounted by as much as 5% from average market prices. According to information on the company's website, the discount on shares purchased with the dividend payment as of Jan. 1, 2013, was 1%.
Whether you purchase new shares through a broker-administered DRIP or directly from the company with no intermediary, for tax purposes, reinvested dividends are treated in the same way as cash dividends, so you get the benefit of the dividend tax credit.
At the same time, it underlines another tax consideration for investing outside a registered account: you must keep track of what you paid to acquire each set of shares because this adjusted cost base is key to properly claim capital gains or losses in the future. With dividends commonly paid quarterly or monthly, record-keeping could become onerous as the number of share purchases you make through reinvestment grows.
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