Whether or not you should reinvest dividends is a question that will cross the mind of almost every ASX investor who builds a reasonable diversified share portfolio of say 15 stocks or more.
Assuming most of those shares pay dividends, it's likely a couple of them will offer dividend reinvestment plans. Some more well known businesses to offer reinvestment plans include Commonwealth Bank of Australia (ASX: CBA), Woolworths Limited (ASX: WOW), Magellan Global Trust (ASX: MGG), Challenger Ltd (ASX: CGF), Macquarie Group Ltd (ASX: MQG) and Dicker Data Ltd (ASX: DDR).
So what is a dividend reinvestment plan (DRIP)?
A company can offer eligible shareholders the right to reinvest dividends to acquire new shares in the company, rather than receiving a cash credit to their nominated account. The new shares will be allotted on top of the original holding.
For example, if your dividend is $100 plus full franking credits and the dividend reinvestment plan price is $10 per share, you will be allocated another 10 shares to your existing holding. In addition, you will still be eligible to claim the franking credit reductions or refunds when completing your annual tax return.
Advantages of a DRIP
- There's no brokerage incurred on a DRIP, therefore it's a cost efficient way to reinvest small amounts without a standard brokerage fee between $10–$20. This may not sound like much, but over quarterly dividend payments (for example) that could be up to $80 a year in savings.
- The biggest advantage of a DRIP is that companies will sometimes offer the shares at a discount to calculated weighted average market price. For example, the Magellan Global Trust offers a whopping 5% discount to the weighted average unit price. More commonly, companies such as Woolworths or CBA may offer discounts between 1%–2% to a volume-weighted average price over a fixed period of around a week, usually up to the record date. Not all companies such as Macquarie will offer a discount though. Generally, where a company offers a discount it's worth ensuring you're satisfied the company is not offering the discount for disingenuous reasons; for example, if it has too much debt and needs to preserve cash. In that instance, you may want to consider selling your shares entirely.
- The other advantage is that, assuming you own shares in a company growing in value over time, then a DRIP allows you to enjoy the benefits of compounding returns.
- For example, if you had received a $500 quarterly dividend from a modest Dicker Data shareholding worth around $22k in March 2019 and reinvested the proceeds at $3.09 per share, you'd have received an additional 162 shares. Less than 3 months later though the shares are worth $5.50 to mean you'd have made a $390 capital gain just on the amount reinvested in one quarter. While a $390 capital gain is not going to change your life, in the context of a DRIP in less than 3 months it shows the power of compounding—but only if you own the right businesses.
- Also remember that when the next dividend payment is made in June, you have an additional 162 shares eligible to collect the 5 cents per share dividend payments. This would only be an additional $8 or so, but shows the compound or multiplier effect in action.
- The key takeaway is that whether you use a DRIP or not is irrelevant, compared to the performance of the stock. For example, if you use a DRIP and the stock falls in value because the company is a dud, then you'd have been better off collecting the cash.
Disadvantages of DRIPs
- Cash is king and you may prefer to collect it to diversify your investments or to just save for a rainy day.
- Some companies offer DRIPs at a discount as they have too much debt or cannot really afford their payout ratios in the first place. So don't participate unless you're confident in the company's motives.
- Companies like Magellan Global Trust or other funds managers will incentivise you to participate with huge discounts, as they're in the actual business of asset accumulation themselves. For example, they'd rather keep the cash to invest and allocate you more units as this puts the power of compounding on their side. This is not necessarily a bad thing, but something to keep in mind.
- For me, the biggest disadvantage of a DRIP is the more onerous record keeping when it comes to calculating final income tax returns of capital gains bill. For example, all reinvestments create new potential new tax liabilities. Therefore, unless you're a committed part-time or full-time investor prepared to put a lot of time into the administration of your portfolio or you have some portfolio administration software (such as Sharesight), you're probably better off just taking a cash payment. Even something like Sharesight still requires time consuming manual entries of reinvestments to keep proper records.
Overall, DRIPs are probably worth participating in, assuming you're in high-quality companies only and are prepared to take on the additional administration around them. Understandably, a lot of people will not fancy the extra admin.
