Earlier this week I was speaking to one of the guys at work about true DRIPs and how they can be a great way to build a position in a company, especially when you are just starting out and when your portfolio is on the smaller side. I wrote about DRIPs and SPPs in an earlier post, but my co-worker had some additional questions about synthetic DRIPs and when (or if) to use any DRIPs at all.

True DRIPs (also called real, classic or authentic DRIPs) are dividend reinvestment plans provided by a company to current shareholders as a way to directly buy additional shares. These DRIPs are handled through a transfer agent such as Computershare or Canada Stock Transfer, with no need to deal with a brokerage. Rather than pay out the dividends in cash in the form of a cheque sent to your house or deposited into your bank account, the company provides additional shares (which includes whole and fractions of shares) which they add directly to your account. For example, if your quarterly dividend is $100 and the current share price is $40, you would receive 2.5 shares. On the next dividend payout even the fractions of shares generate more dividends, thus compounding the growth. Many companies offer a discount off the current market price when purchases are made through a true DRIP, which helps your position grow even faster.

Not To Drip

Synthetic DRIPs work much the same way, with a few notable exceptions: they are sponsored by the individual brokerage you deal with and they can only provide whole shares. In this case any cash remaining from a dividend after purchasing whole shares will be returned to your account to do with as you please. Using the same example from above, if your quarterly dividend was $100 and the current share price was $40, you would receive 2 shares (totaling $80) and the remaining $20 would be placed in your account. Though your total number of shares will grow a little slower with a synthetic DRIP, it does have some advantages that true DRIPs do not. Because synthetic DRIPs are held with a brokerage, you can drip them inside a TFSA or RRSP, sheltered (or at least deferred) from taxes. Be sure to ask your brokerage whether they honour any DRIP discounts as well, as some will give you the same discount off the market price for your synthetic DRIP as offered through the true DRIP.

There can be some fees associated with DRIPs, and you need to be aware of these before you start. In Canada almost every true DRIP is free once you’re set up. However, to enroll most companies require at least 1 share to be registered in your name, and the cost for this tends to range from $30-$50. On the flip side, most discount brokerages in Canada will do a synthetic DRIP for free. You simply need to phone in as ask them to DRIP your shares of Whatever Corp and they take care of the rest. The list of companies that brokerages offer DRIPs for can vary widely however, so you may wish to take this into consideration when choosing where to hold your accounts.

If you wish to true DRIP a US company it adds a whole new challenge. According to the US Securities and Exchange Commission any foreigner purchasing stocks must do so through a US bank or a foreign bank that has a branch located in the US. Don’t confuse this with a Canadian account that trades in US dollars. The account needs to actually be either physically in the US (opened at a US branch even if you do your banking online up here in Canada), or more conveniently for many of us, through an online US bank. Synthetic DRIPs for US companies can be handled in Canadian based accounts, but currency conversion fees will eat into your dividends, and this will happen on each DRIP transaction. If this seems too complicated you may decide simply to invest the dividends somewhere else.

The question of whether or not to bother with DRIPs is up to the individual investor, both in how much effort you want to put in, as well as how strongly you feel about your holdings. I’m a big fan of DRIPs (gotta love the set-it and forget-it style of investing!), but they may not be right for everyone.

There is a fair amount of work involved in true DRIPs, especially in setting them up. Application and anti-money laundering paperwork needs to be filled out and submitted for each company you plan to DRIP. True DRIPs are held in taxable accounts as well. Though they are taxed favorably in Canada (usually much lower than your marginal tax rate), if you have the room in a TFSA or RRSP you could shelter them there. This is exactly what I do – build my position as quickly as possible through true drips, then transfer them into my TFSA in order to shelter all future growth, and start a synthetic DRIP from there.

As I mentioned above, using a synthetic drip is much less hassle. Simply call up your brokerage and tell them you would like to drip every stock in your account. Assuming a synthetic drip is possible through your brokerage, and that the dividend amount is at least enough to buy 1 whole share, they will start the drip and you can sit back an watch the new shares roll in each quarter. There is really very little involved with synthetic DRIPs.

I was trying to come up with a reason why an investor would not want to DRIP their shares of a specific company, and I could only really see one: If you would like to do something else with the dividends, such as invest in a different company or product. The dividends are, of course yours to do with as you please and you could choose to use that money to invest in whatever else you like. You can even withdraw the cash to spend instead of investing (keeping in mind any penalties and tax considerations depending on the account you hold them in.) This is exactly what we Drippers will do when we retire – use the dividends as income.

My plan basically involves buying strong, solid companies that I’ll hold and build my position with for many years, hopefully into retirement. That means I’d rather use each dividend as efficiently as possible to buy more shares of the same company. Assuming I’ve chosen the right companies and they still fit within my investment plans, I’m going to want as many shares as possible and dripping (either true or synthetic) helps the whole process move along faster. For me dripping is a no-brainer, and quite a bit of fun to watch as my number of shares increases each quarter.

What about you? Do you DRIP every stock, pick and choose, or just let the cash roll in?

Happy Dripping!