DRIPs (Dividend Re-Investment Plans) and cash option plans let individual investors build their wealth. That’s thanks to the dozen advantages that we outline below.
Studies show that dividend reinvestment is crucial in building wealth. So make use of DRIPs (Dividend Re-Investment Plans). Companies with DRIPs are willing to reinvest your dividends into new shares. You can build wealth even faster with cash option plans. That is, you write a cheque to buy more shares. DRIPs give you a dozen advantages.
1. DRIPs in Canada cut brokerage fees. Such is not always the case with American DRIPs. But in the US you can now buy fee-free stocks.
2. DRIPs let you buy stocks gradually. Having modest dividends automatically reinvested is easier on the nerves than investing big sums all at once. Particularly during stock market setbacks.
Dollar-cost averaging cuts your price risk
3. DRIPs let you profit from volatile stock markets through ‘dollar-cost averaging’: that is, regularly invest fixed sums and you buy more shares when prices are lower and fewer shares when prices are higher. You buy your shares at average prices.
4. You avoid bid-ask spreads (paying the higher ‘ask’ price and receiving the lower ‘bid’ price).
5. Cash option plans help you resist the risky and futile strategy of ‘market timing’ (trying to buy at the bottom and sell at the top—at the ‘right time’).
6. Most companies and real estate investment trusts with DRIPs are of high quality. In fact, we rate 61 of 72 as either ‘Very Conservative’ or ‘Conservative’.
7. Dividend-payers keep you out of scams. Rising dividends improve your chances of making price gains. Income-seeking investors are likely to bid up the prices of stocks with rising dividends.
8. DRIPs give you compounding. As your reinvested dividends buy more shares, your dividends grow exponentially. And all of your dividends work for you. One study found that a dollar invested in the US stock market from 1926 to the millennium grew to $105.96 from capital gains. Reinvest the dividends, however, and that dollar grew to $2,591.79.
9. DRIPs put your dividends to work immediately. This beats letting them sit idly in your account.
10. DRIPs amount to ‘forced’ savings plans: you can’t spend dividends that you don’t receive.
11. The dividend tax credit on Canadian stocks reduces the tax department’s bite. But interest income is fully taxed outside of registered accounts.
12. 32 Canadian investments we cover will reinvest your dividends into new shares at a discount to their market prices. That is, you profit right from the start.
DRIPs’ three drawbacks
If you live off dividends, or if your cash flow is constrained, you may find DRIPs unsuitable. That’s because DRIPs squeeze your cash flow. But if you have sufficient cash flow, then it’s worth enrolling in DRIPs. The fact is, they remain a great way to build your wealth.
A second drawback of DRIPs is that they can increase your income taxes. In taxable accounts, when a company reinvests your dividends into new shares, you face income taxes, just as if you had received a cash dividend. The fact is, if you reinvest dividends in many DRIPs, you’ll likely face a large tax bill without the cash to help you pay these taxes. The Canadian dividend tax credit only offsets part of the tax department’s bite. This criticism does not apply to DRIPs in tax-sheltered accounts such as Tax-Free Savings Accounts, RRSPs and RRIFs, if they let you make use of DRIPs at all.
A third drawback of DRIPs is that grossed-up dividends can raise seniors’ reported income. This can reduce or eliminate their means-tested benefits, such as Old Age Security and the Guaranteed Income Supplement.
This is an edited version of an article that was originally published for subscribers in the December 13, 2019, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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