Monday, 17 October 2011

Thinking about DRIPing

If you're new to dividend investing, there's no doubt that you'll come across DRIPs when you are doing research. Some people swear by DRIPs while others wouldn't touch them with a 10-foot pole. What exactly are DRIPs and how will you know if they will help you reach your financial goals? Let's take a closer look at Dividend ReInvestment Plans.

DRIPs are offered by companies to help shareholders get their hands on more shares without having to pay commission fees (which are a huge drag on performance - money used to pay the broker could have been invested). As you can probably tell from the name of the plan, dividends that are normally distributed are instead used to purchase shares of the same company that distributed the dividends.

There are many perks to using DRIPs to accumulate shares of your favourite company. As mentioned before, purchasing shares with a DRIP is commission free which will add up over the long run. DRIPs also allow you to always be invested, letting the power of compounding work some magic. This is even more so if you decide to run a full DRIP which would purchase fractional shares. Rather than have money sitting on the sidelines waiting until you amass enough funds to purchase additional shares, the dividends are invested as soon as you get them. Certain companies also offer a discount on the market price at the time of the dividends getting distributed. You also take advantage of dollar-cost averaging and the fact that you don't have to constantly follow the market to decide when to buy shares which is great for an investor who wants to set it and forget it. There is also the option to turn off the DRIP whenever you feel like you would rather have the cold hard cash rather than more shares.

There were many times that I wanted to increase my position in a stock but didn't have enough dough to justify paying the commission fee. My general rule is to not have the commission fees be more than 1% of the money that you are investing, and because of this, sometimes I get paid dividends but I can't do anything with them! Sometimes it could be as long as a couple months before I can get enough money to invest, especially during the school year when I'm not working full-time hours. This can be frustrating when the entry points are attractive but I can't buy in.

Along with the perks, there are some downsides to using DRIPs. One of the issues that I have with it personally is that I have no say in when to reinvest the dividends - they are automatically used to buy shares at the market price the moment that they're handed out. Another downside is that if you are running a synthetic DRIP, then you must own enough shares of the stock so that the dividends being paid out is large enough to cover at least one additional share (the remainder of the dividends after purchasing as many whole shares as possible will be added to the brokerage account as cash). Full DRIPs can be time consuming and actually cost some money to set up.

After laying all the cards on the table, I feel that DRIPs are useful tools to help reach my financial goals. The only turnoff for me is the fact that I cannot choose when to invest*. I'm well aware that it's near impossible to time the market and I don't believe that I have that gift. I can however, average down (buying more shares when the market price is lower than my average price paid) which isn't timing the market since I'm not really waiting for a bottom - whenever I can average down I would take the opportunity. I'm also aware the averaging down is sometimes frowned upon but in this case I don't see a problem.

If you are going to DRIP then you made the commitment to invest in the company for the long term, so if I average down then I have the same faith in the company. The reasoning behind dollar-cost averaging is that when prices are high, I would purchase less shares and when prices are low I would purchase more shares (since the same amount of money is being invested regardless), but who wants to buy less shares at a high price? By holding money and waiting to average down I would always be buying when prices are low, netting me more shares.

Wait Paperboy! Weren't you complaining about having money sidelined a mere 4 paragraphs ago? Indeed I was my sharp reader, but hear me out. Asset allocation is used to mitigate risk by spreading out money into different sectors of the stock market. If this is done correctly, then an investor's portfolio would usually have some stocks making money and some stocks losing money. That's when you average down! There should always be a place to put the money therefore eliminating the sideline problem. Think of it as "tactical common stock allocation".

Do you guys use DRIPs? Am I missing any benefits? Am I missing any downsides?

-the Paperboy

*That's really my only concern with DRIPing and I could be way off base with how I solve the problem because I'm by no means an expert on the matter so as always do your own research before making any financial decisions.

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