To DRIP or not to DRIP

By: ispeculatornew
Date posted: 10.15.2010 (4:42 am) | Write a Comment  (4 Comments)

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Many of our readers, like ourselves, believe that one of the best forms of investment is to build a solid passive income portfolio composed mostly of reliable and steady growth dividend stocks. Of course, as I’ve written in the past, you can start such a portfolio with as a little as a few hundred dollars, the important being to get started rather than delay the decision for months.

Once the account is open, the goal is to build a portfolio that will provide a steady and growing source of income that can one day be used as a source of income. I specify one day because you will have a hard time building a big portfolio if you do not reinvest your dividends. Why? Because the growth of your portfolio comes from only 3 areas:

-Investments into the portfolio
-Payout increases by stocks that are owned
-Reinvestment of the current dividends

The 3 are crucial and while #1 is the most important to start off, as time goes by and compounding rules come into action, all 3 of them become very important. It is obvious how to make contributions to the portfolio. Payout increases depend on the steady growth of the dividend stocks that you own. If you want more info on selecting the right ones, we recomend joining our free newsletter which gives you an analysis of the best dividend stocks every month. Join by signing up in the form below.

The third way of improving your portfolio is through dividend reinvestment. The question is how to do it. If you decide to simply cash in those dividends and reinvest them in the same way that you invest your contributions, that can work fine and help you achieve your goal

There is another way…DRIP

However, there is another way, through a DRIP, a Dividend Reinvestment Plan. What is it? It’s a plan offered by corporations to help investors reinvest their dividends automatically. Simple? Here is a quick example. If you own 100 shares of Proctor & Gamble (PG), you are currently receiving $48,18 per quarter. If you cash that dividend, you will of course receive $48,18 in your account. If you were using a DRIP, you would be buying for $48.18 of PG stock. In this particular case, that is about 0.70 shares.

Can I really own part shares?

Yes for some brokers, through DRIP’s you can generally own part of shares. The goal being to reinvest your entire dividend into that company. The only requirement is generally for the dividend to be worth at least $10. Unless you own a couple of stocks, that is generally not a problem.

For other brokers, they will credit you with full shares and pay you back the difference.

Why would I do it?

There are many reasons to use the DRIP, here are a few:

-Some stocks offer discounts when you buy stock through DRIP. That means you are actually paying less for the stock

-You are not paying a commission in most cases on these transactions

-You profit from additional compounding. Instead of waiting to have a few hundred dollars, enough to buy shares of a dividend stock, you can reinvest automatically when you received the dividend.

-If you do not trust yourself, using the DRIP takes away the temptation to spend that money. Shouldn’t be

How to do it?

It varies a lot and there is no doubt that the best way to get started is by asking your broker (where your shares are), about DRIP, the conditions, which companies it is possible to use it on, discounts, commissions, etc. It varies, but it’s well worth looking into. Sometimes, it does require some administrative work, forms filling and others. I would say that it is at least worth looking into what needs to be done before deciding if it’s worth the trouble or not.

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4 Comments

  1. Comment by Imran — January 7, 2011 @ 8:31 am

    Assuming the investment is not in an RRSP or TFSA:

    If one is using a DRIP, doesn’t he pay taxes on the dividends? And if so, wouldn’t it be better to own stocks that don’t pay dividends since you don’t plan to take the money out just yet?

    A company that doesn’t pay dividends reinvests all its earnings in the company, and nothing goes to the government until the shares are sold. All else being equal, wouldn’t this be a better investment?

    Why give the government a cut right away?

  2. Comment by IS — January 8, 2011 @ 8:41 am

    @Imran – That is one of the discussions with no end about dividend investing of course yes. You could certainly argue it your way but you could also build that portfolio in a non-taxable account.

    Also, it’s important to note that dividend companies have generally overperformed to compensate for that fact but it’s a fair point, no doubt.

  3. Comment by Randy S. — June 15, 2011 @ 11:43 am

    I believe that if you are using an IRA or 401K (U.S.A) then any dividends are not taxed.

  4. Comment by IS — June 15, 2011 @ 5:19 pm

    @Randy S. – Yes that is correct. If you use dividend stocks in “non-taxable accounts”, you will be exempt.

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