Dividend reinvestment plans (DRIPs) are investment programs run by publicly traded companies to invest in them and provide shareholders with partial shares reinvested back in the company instead of paying out cash dividends each quarter (or whatever the dividend schedule is). This is advantageous to the companies since they can keep the money in the company where it can be put to good use while providing investors greater stake in the company through the share reserve. Companies usually run these programs through a transfer agent or a brokerage firm. This article takes a look at the overview of the DRIP program and the various advantages and disadvantages to investors using this methodology.
When investing via DRIP, there are a few terms used liberally, and I want to include them here as I use them in the article below. A Share Purchase Plan (SPP) allows you to buy more shares in the company in the future. This is usually a recurring event that you set up with the Transfer Agent or Broker. An Optional Cash Purchase (OCP) is a one-time optional purchase of more shares in the company.
- Warning! GuruFocus has detected 5 Warning Signs with BNS. Click here to check it out.
- BNS 15-Year Financial Data
- The intrinsic value of BNS
- Peter Lynch Chart of BNS
The following are the advantages and disadvantages of the DRIP program.
Advantages of DRIP
- Commission-free: Enrolling in the DRIP program does not cost the investor any money. The program is sponsored by the company, so there are no brokerage fees or transaction fees to worry about.
- Partial shares: Investors can choose a certain dollar amount to contribute by enrolling in the SPP or using the OCP to buy partial shares in the company. When dividends are scheduled, partial shares from the reserve are allocated instead of distributing the dollar amount.
- Discounts: Some companies provide discounts for registering in the DRIP program. These discounts can vary anywhere between 1% to 5%, which means higher dividend rate and yield-on-cost on your overall returns.
- Dollar Cost Averaging: Enrolling in SPP or using OCP offers investors the opportunity of taking advantage of dollar cost averaging. This is one of the cornerstones of long-term investing, and you are able to build your equity slowly.
Disadvantages of DRIP
- Setup Effort: Setting up the program and getting started takes a lot of time and effort. Also, getting your first share and setting up is confusing for starters, which deters people from enrolling in these programs.
- No Control on Stock Price: Due to the way the payment structures are set up with SPP or OCP, the investor can only choose the amount of money invested and has no control of the price paid on the stock. The Transfer Agent or Broker simply takes the closing market price of the stock on the date it chooses to execute the plan.
- Where's the money? If you depend on and need to withdraw income from your investments, DRIP programs do not work out, as you don't actually see the money. All you get is more equity in the company.
- Taxation: Although listed as an advantage by a lot of writers (due to dividends being taxed favorably), taxation can be a double-edged sword. I consider taxation more of a disadvantage than an advantage due to the fact that there is no tax shelter when investing using a DRIP program. Consider all the taxation involved when investing via DRIP — (a) the companies pay out their dividends after they have paid their due taxes, (b) you are investing in the company after paying your income taxes, (c) you pay taxes on the dividends received, and (d) you pay taxes on the capital gains. If the money was invested in registered accounts instead, you would be sheltered from some of the taxes mentioned earlier.
The taxation point is a big thorn for me personally. Even though I have a DRIP account with one company, The Bank of Nova Scotia (NYSE:BNS), I am not convinced that DRIP programs are that great. Do you think there is any value in DRIPping outside tax-sheltered accounts (even with the DRIP discounts)?
Disclosure: I am long BNS. See my full list of holdings here.