Dividend reinvestment plans are a great way to get your money working for you and offer all kinds of advantages to beginner and more seasoned investors alike. But many people are unfamiliar with dividend reinvestment plans (DRIPs). In this first post in my series on DRIPs I want to look at the types of DRIPs, what they are and look at some of their distinguishing features.
A DRIP is simply a dividend reinvestment plan. Generally speaking, when a company pays a dividend, shareholders have the option to take that dividend in cash or reinvest it to purchase additional shares in that specific company on a commission free basis. There are 2 types of DRIPs and as a beginner investor it is important to know their features.
A true DRIP is one that is set up directly with a company through its transfer agent. In Canada, the two major transfer agents are Canadian Stock Transfer (CST) and Computershare (CS). There are three key advantages of a true DRIP. First, the service is free and allows an investor to accumulate additional shares at no extra cost.
Second, 100% of the dividends are reinvested and this is important for those just starting out as it allows the investor to constantly grow his/her holdings in a given company because those fractional shares are earning additional dividend income. So you get 100% of your reinvestment dollars working for you.
The third advantage of a true DRIP is that many offer something called a Share Purchase Plan (SPP) where an investor can send Optional Cash Purchases (OCP) to buy additional shares in a particular company. This is a huge bonus because beginner stock investors want to keep their trading costs as low as possible.
The second type of DRIP is offered by discount brokers and is called a synthetic DRIP. The key differences are that with a true DRIP 100% of the dividends received can be reinvested to purchase additional shares (even fractional shares); while only whole shares may be purchased through a synthetic DRIP and the remainder of the dividend is paid out in cash into your brokerage account.
The second major difference, of course, is that in a discount brokerage account you pay commissions to buy and sell stock. They do not offer commission-free Share Purchase Plans (SPPs).
See my other posts on dividend reinvestment plans (DRIPs):
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