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 have shown that dividend reinvestment is crucial to 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.
One is that 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.
Two, DRIPs let you profit from volatile markets through ‘dollar-cost averaging’: regularly invest fixed sums and you buy more shares when prices are lower and fewer shares when prices are higher. As a result, you buy your shares at below-average prices.
Eliminate or minimize your trading costs
Three, DRIPs in Canada cut brokerage fees. Such is not always the case with American DRIPs.
Four, you avoid bid-ask spreads (paying the higher ‘ask’ price and receiving the lower ‘bid’ price).
Five, 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’).
Six, most companies and real estate investment trusts with DRIPs are of high quality. In fact, we rate 59 of 70 we follow as either ‘Very Conservative’ or ‘Conservative’. And 42 are Key stocks.
Seven, dividend-payers keep you out of scams. Rising dividends improve your chances of making price gains. As investors seek income, they’re likely to bid up the prices of stocks with rising dividends.
Eight, DRIPs give you compounding. As your reinvested dividends buy more shares, your dividends get bigger. And all of your dividends work for you. One study found that a dollar invested in the U.S. 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.
Nine, DRIPs put your dividends to work immediately. This beats letting them sit idly in your account.
Ten, DRIPs amount to ‘forced’ savings plans: you can’t spend dividends that you don’t receive.
Eleven, the dividend tax credit on Canadian stocks reduces the tax department’s bite. But interest income is fully taxed outside of registered accounts.
A twelfth advantage is that 33 Canadian investments will reinvest your dividends into new shares at a discount to their market prices. That is, you profit right from the start.
Enrolling in DRIPs is time well spent
Enrolling in DRIPs involves a bit of paperwork, but it’s time well spent. Here are the four steps for enrolling in a DRIP.
1) Do you need a brokerage account? Not if you buy shares directly from 300 or so U.S. companies, including some of our U.S. Key stocks. By contrast, you’ll need a broker or a stock-holding friend or relative to buy shares in Canadian companies that offer DRIPs.
Buy a lot upfront if there’s no cash option
2) Buy shares through your broker. If you want to buy one or a few shares, make sure the company has a cash option plan. Later on, you can write a cheque and buy more shares. When companies lack cash option plans, it’s best to initially buy more shares. If you buy just a few, it’ll take years for your reinvested dividends to buy another share.
3) Have your broker register the share certificate in your name. You need to be a registered shareholder to make use of a DRIP. Most full-service brokers will register shares in your name at no extra cost, though they’re unlikely to tell you about DRIPs. Discount brokers, by contrast, often charge for this extra service. To register the shares in a child’s name, ask your broker about opening a trust account. The waiting period to receive a certificate is usually two weeks. Keep certificates in your safe-deposit box.
4) When you receive the stock certificate, call the company or its transfer agent and ask for a DRIP registration form. When you complete the registration form and return it, much of your initial work is done. You’ll receive a transaction summary after each dividend is reinvested. You’ll also get a year-end report describing all purchases made during the year, both cash investments and dividend reinvestments, along with your yearly T5 Supplementary tax form.
You can withdraw your shares at will
You can ask for share certificates from the plan. Or, should you require money from the plan, you may withdraw all or part of your shares at any time.
It takes more than a DRIP to make a stock suitable for your portfolio. The best choices are companies that pay you steadily-rising dividends. Stocks in cyclical industries, such as resources, may cut your dividends in tough times. When dividends are cut, so is the rate at which you accumulate new shares.
The Investment Reporter, MPL Communications Inc.
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