In this second post in my series on Dividend Reinvestment Plans (DRIPs), we look at their advantages and disadvantages? The primary advantage of participating in a DRIP of any kind is that it allows an investor to take advantage of compounding by regularly reinvesting dividend income to purchase additional shares in a company.
So, for example, the Bank of Nova Scotia (BNS) pays a quarterly dividend of $0.64 per share. If someone had 100 shares of BNS they would receive $64 per quarter. If that person chooses to reinvest that dividend and assuming that shares in BNS are trading at $64, then that person would receive 1 additional share of BNS. The following quarter that investor now has 101 shares of BNS and the new quarterly amount he or she would receive is now $64.64 and so on.
While an additional $0.64 per quarter doesn’t seem like much, over time that amount can really add up, especially in a true DRIP. For instance, if one where to continue dripping BNS shares over a 30 year period, assuming a 4% annual growth in the dividend and 5% annual growth in share price, the original 100 shares would have grown to 277 with a value of over $76,000. Not bad for an initial investment of $6,400!
Another advantage of dripping is that the additional shares are purchased without paying any commissions. As many of you are aware, whenever you purchase stock you pay brokerage commissions. Nowadays there are many discount brokerages that offer commissions as low as $4.95 per trade. I use TD Waterhouse where I pay $9.99 per trade. At either of those rates though it’s simply not economical to purchase 1 or even a few shares of BNS. A third advantage of dripping is that some companies from time to time have offered a discount ranging from 2%-5% on reinvested dividends. Essentially you are getting more bang for your buck by reinvesting the dividends.
A final advantage to dripping is the benefit of dollar-cost averaging (DCA) – when you invest a set amount in a stock on a regular basis over a long period of time. Some shares will be purchased at higher prices, while others will be purchased at lower prices. The important thing to remember about DCA is that over time the peaks and troughs average out.
What are some disadvantages of DRIPs? In general, a disadvantage to dripping is that the investor does not control the price he or she pays for acquiring additional shares, although it does average out over time as discussed above. More importantly, however, is that when it comes time to sell the shares in a true DRIP account, you do not control the timing or the price at which you sell. The reason you don’t control the timing or selling price is that Transfer Agents typically sell in batch sales usually at the end of the month. To get around this, some people choose to build up the number of shares they own in a true DRIP and once that number reaches 100 shares they request a certificate for those shares and deposit them into a discount brokerage account.
Another disadvantage of a true DRIP is the paper work involved. It is up to the individual investor to keep track of all the dividends and OCPs so that he or she can figure out the ACB of the shares. I personally use an excel spreadsheet to track this and I keep the annual statements I receive from the Transfer Agents as hard copies in case I ever need them. A final disadvantage of a true DRIP is that it is strictly a non-registered investment account where your dividend income and capital gains are taxable. In a self-directed account through a discount brokerage one can set up a synthetic DRIP in an RRSP, RESP or TFSA and enjoy the benefits that tax-sheltered accounts offer.
See my other posts on dividend reinvestment plans (DRIPs):
See also Lowell Miller’s classic on dividend growth investing: The Single Best Investment: Creating Wealth with Dividend Growth