A DRIP or dividend reinvestment plan allows investors to automatically reinvest their dividends for additional shares in the company. Using this method, the investor will still receive the franking credit and will still be taxed on the cash value of their dividend. So, should investors elect to reinvest their shares? how do they? and what are the pros and cons? How to set up a dividend reinvestment plan.
Not all companies offer a DRIP. To find out if yours does simply visit the associated share registry. Some companies may also offer a DRIP with a slight discount to the market value for investors. The generic method is that investors are not automatically set up to participate in the DRIP. This means that when they receive a dividend payment the cash value will be deposited within their nominated account, from here they can do as they please with the money.
How To Set Up A Dividend Reinvestment Plan
To find the Share Registry, use our Share Registry Look-up Tool.
In Computershare it’s as simple as going ‘my profile’- ‘Reinvestment plans’ and selecting the company and electing to participate in full or partially. That is either the entire amount or a partial amount of your dividend is reinvested. On Link you simply click view details of the company of interest and update it in the ‘payments and tax’ section.
One of the most common concerns people have about the DRIP is what happens if I don’t have enough to buy a full share? A lot of investors are worried that they will lose the amount of their cash amount that falls short of buying a share. This isn’t the case. The amount that falls short will be simply kept until further dividends when it is brought forward to be reinvested. Additionally, if you sell all your shareholdings these residual amounts will also be paid out to you. One thing to keep in mind is that some companies (very few) will have the option to credit the residual amounts to a charity. One example of a company that does this is Telstra. In this case just ensure that you have elected to keep the residual amounts. If you are worried about this simple search for the company’s name and put ‘dividend reinvestment plan’ rules after it. This will bring up all the necessary information for the DRIP.
By electing in a DRIP, you will still receive all the standard dividend statements. This statement will also show how many units you received, the share price they were reinvested at, and the residual amount left over. Here’s an example of what this look like.
The Pros and Cons of a DRIP for investors:
Arguably the biggest advantage of the DRIP is that it is an automatic simple process that allows investors to compound their holdings. Once you elect to have your dividends reinvested it is easy to set and forget, there is no need to consider reinvesting the money yourself there is no temptation to spend the money, it is simply put back into the company to grows your holdings. This allows compounding to take place. Thus, each time you will have a growing number of shares that will receive dividends. For quality companies that maintain and grow their dividend each time you will receive a greater number of shares and a greater amount of dividends. Over time this will allow you to compound and exponentially grow your holdings. Here’s what this looks like on a graph.
This chart is based on a $5000 investment per year, total investment $100,000. With an investment yield of 10%, and 10% assumed growth rate. Note this does not account for any discount to market price. This really highlights the effects of compounding growth.
Another advantage of DRIP is that additional units are acquired without brokerage fees. If you use your payments to manually buy more shares you would have to pay brokerage for doing so. DRIPs eliminate this fee.
Additionally, from time to time some companies may offer a discount to the market value, to entice investors to participate. Shares purchased under the DRIP may be available at a slight discount usually 1-5% of the market value. For example, Commonwealth Bank in the years 2017 and throughout 2009 offered discounts around 1.5%. For these blue-chip companies around 20-30% of investors utilize a DRIP.
DRIPs are only really suitable for long-term investors. If you’re not planning on holding a company, there’s no real reason to participate. One of the main disadvantages people see in a DRIP is the lack of choices. In a dividend reinvestment plan, there is no availability to plan a target price and a target company, it is all automatically complete. Though many see this as an advantage it does mean that you’re investing in that select company no matter the price. As such you may see it as overvalued at a particular time. Additionally, this can also mean that your holdings may be skewed overtime to this one company. As such it is important to ensure that this one company is maintain a suitable proportion of your portfolio that is in line with your goals and risk tolerance.
Dividend Reinvestment Plan Tax
Arguably another big factor is the taxation. The dividends from a tax perspective are treated as if you received them in cash and then purchased additional shares. From a tax perspective when you eventually sell the capital gains can be more difficult to calculate as you have multiple different cost basis. As such record keeping is essential.
All above information does not take into consideration individual investor needs or profiles. These are not recommendation. The investment landscape as a whole is constantly changing, and these summaries may not be representative. Investors should seek individual professional advice. This information has been edited and checked but some incorrect or outdated information may still be present. This is for a guide only and is not investment advice. Prophet is not a financial advisor.