A dividend reinvestment plan (DRIP) is a plan for shareholders of a company that allows them to reinvest their dividends with the purchase of more shares. In most DRIPs, when the cash from the dividend is used to buy more shares there is no fee/commission charged. This is the main advantage of a DRIP, low or no fees. There are other advantages too, but I’ll go into those later on.
There are two types of DRIPs, a synthetic DRIP and a traditional DRIP.
A synthetic DRIP is a service offered by your broker. It depends on your broker, but most will not reinvest in fractional shares. This means that you’d need enough dividends from one payment to cover the cost of the share. To enrol in a synthetic DRIP, you have to contact your broker and ask to be enrolled. It doesn’t normally cost anything to enrol in a synthetic DRIP.
A traditional or true DRIP is the plan that is offered by the company. The company uses a transfer agent to administer the plan. Through the transfer agent you can reinvest your dividends to buy fractional shares. Some companies will even give you a discount on the share price. The discount usually varies from 1-5%. You see these discounts with some Canadian companies, but very rarely for US companies. To enrol in a traditional DRIP you have to be an existing shareholder. This usually means buying one share and then using that share to enrol. Depending on the company DRIP you choose it can be complicated getting the single starter share that is used to enrol in the DRIP. Because of the difficulties of enrolling in a traditional DRIP, most people only enrol if the company also offers a Share Purchase Plan (SPP). A SPP will allow you to buy additional shares through the transfer agent to add to your DRIP.
What is a Share Purchase Plan (SPP)?
A Share Purchase Plan (SPP) is a plan offered by the company and administered through a transfer agent that allows the shareholder to purchase additional shares with no or very little fees. Yes you heard that right, no fees! The plan will vary depending on the company plan, but you will be able to buy additional shares using pre-authorized debit, or mailing a cheque/check to the transfer agent. Usually the plan will let you purchase additional shares on a monthly or quarterly basis, but it can be weekly or other intervals too. This is one of the disadvantages compared to a broker, because with a SPP you lose some control and you can’t pick the price or the time you want to buy shares.
Say you have a SPP that offers monthly optional cash purchases. This means that on a set date each month shares will be purchased based on the price at that time or an average of the prices at that time. Prior to this date you send money to the transfer agent and then the shares are purchased for you. This means that shares are only purchased 12 times out of the year and whatever the price is, that’s what you get. This differs from a broker, because with a broker you can set a limit order and pick the price you want to buy at. With a broker you can also buy shares whenever you want. A broker however will charge you fees, whereas a SPP in most cases will charge you no fees to invest in additional shares. In some rare cases you will also be offered a discount on the share price (ranges from 1-5%). This is not very common, and mostly occurs for Canadian companies.
The big advantages of the traditional DRIP with a SPP compared to a synthetic DRIP is that you can buy additional shares often without any commission or fees.
Confused yet? Let’s look at some examples…
Fractional Share vs. Whole Share Example #1:
Say you receive $50 as a quarterly dividend payment, but the share price is $100. If the DRIP allows fractional shares (A traditional DRIP) then the $50 would be reinvested and half (0.50) a share would be added to your account. If the DRIP does not allow fractional shares (A synthetic DRIP) then the $50 would not be enough to buy a full share, so it would be deposited as cash in your account.
Fractional Share vs. Whole Share Example #2:
Say you received $125 as a dividend payment, and the share price is $100. With a synthetic DRIP the $100 would be used to reinvest and buy one share, and the remaining $25 would be deposited as cash in your account. If you had a traditional DRIP that allowed fractional shares then 1.25 shares would be purchased.
As you can see from these two examples the traditional DRIP offers the advantage of being able to buy fractional shares. This can be a significant advantage if your dividend is regularly lower than the share price making it impossible to participate in a synthetic DRIP.
Share Purchase Plan (SPP) vs. Broker Example #1:
Say you have $150 you want to invest in Company ABC and the current share price is $100. To buy shares your broker will charge you $10. With a SPP you will be able to buy fractional shares so you buy 1.5 shares and all of your money went to buying shares. In the broker’s case you can only buy whole shares, so only 1 share is purchased. $100 went to purchase the share, $10 went to the broker and you are left with $40 cash still in your broker account.
You’ll notice from this example that the $10 fee you were charged by the broker represents 9.1% of the total $110 you spent to buy 1 share. Keeping investing expenses low is an important component of an investment plan and I usually recommend keeping your fees to 1% or less. If you go with the broker, 9.1% of the money is going to the broker. This is very high, especially when you consider that this is only half the picture. You will be charged another $10 when you go to sell the stock (SPPs will usually charge you to sell a stock too).
This example explains why investors only looking to invest small amounts at a time would choose a SPP. If you are looking to invest a set amount like a $100 per month SPPs are a better option because they have significantly reduced fees compared to brokers and you will be able to spend the whole $100 on shares because you can buy fractional shares. You might not think $100 per month is much, but it adds up over time and every little bit helps.
One of the reasons I first started a DRIP & SPP is that I wanted a low cost way to invest small amounts on a monthly basis. I only had a small amount of disposable income to invest each month, and DRIPs and SPPs provided a way for me to start investing and learning.
I often hear of parents setting up traditional DRIPs and SPPs for their kids so that they can start learning about money and investing at an early age. Some SPPs have a set minimum usually around $50 to $250 that you have to invest, but others have no minimums. For instance Bank of Montreal’s (BMO Trend Analysis) SPP has no minimum, so you could invest $5 if you wanted. This situation can be great if you are trying to teach your child how to invest at a young age because they can use their own money; $5 for candy and $5 for BMO.
This example really highlights the advantage of a SPP versus a broker when investing small amounts of money, but when you start investing more money the advantages aren’t as great. Let’s take a look at another example.
Share Purchase Plan (SPP) vs. Broker Example #2
Say you have $2,050 you want to invest in Company ABC and the current share price is $100. To buy shares your broker will charge you $10. With a SPP you will be able to buy fractional shares so you buy 20.5 shares and all of your money went to buying shares. In the broker’s case you can only buy whole shares, so 20 shares are purchased. $2,000 went to purchase the shares, $10 went to the broker and you are left with $40 cash still in your broker account. The main difference between this example and the previous one is that the fees as a percentage of the total investment have dropped from 9.1% to 0.5%.
In this example, because the fees are much lower as a percentage of the total invested amount, the SPP advantages aren’t as great.
Traditional DRIP & SPP vs. Broker, What’s Better?
Both! If you talk to other DRIPers you will soon find out, that while they are huge fans of DRIPs, they also have a broker account that they use. I find that a lot of the time investors use DRIPs and SPPs in conjunction with an online brokerage. Initially the DRIP and SPP are setup because they don’t have a lot of money to invest, they want to learn, or only want to contribute a small amount at a set interval (weekly, monthly, quarterly, etc.). DRIPs and SPPs offer a low cost way to accumulate shares and learn about investing.
Later on when the investor is more comfortable and has more money they start using the broker account more. Traditional DRIPs and SPPs cannot be setup in tax sheltered accounts, so often investors will use the traditional DRIP and SPP to accumulate shares and then transfer their shares to the online brokerage where they can be moved into a tax sheltered account. Transferring shares from your DRIP account with the transfer agent to your broker doesn’t usually involve any fees.
Side note: To transfer shares from a traditional DRIP to a broker account you have to transfer the shares to a taxable account at your brokerage. When the shares show up in the taxable broker account they can then be transferred to your tax sheltered broker account.
Another common reason DRIPers transfer shares to their broker account is because they have accumulated enough shares so that when the dividend is paid it can be used to buy at least one share. This means they have enough shares to enrol in a synthetic DRIP with their broker.
Most DRIPers are long term investors that have a buy and hold/monitor investment plan, so they aren’t overly concerned with selling their shares. Eventually most investors will have to sell their shares at some point. This is when it is useful to have a broker account because you have more control over the price and time at which you sell the shares. For instance, it is a common practice among dividend growth investors to sell a stock immediately if the dividend is cut. If you are setup in a traditional DRIP they might not process your sell request right away because it’s part of a batch order, or because they typically process the request slower than an online broker. In these few days you might lose a significant portion of your investment because a stock price typically drops significantly after a dividend cut. With a broker you can pick the time or price you want to sell at. This is one of the disadvantages of the traditional DRIP and SPP.
To mitigate this disadvantage a common technique is for DRIPers to use traditional DRIPs and SPPs to accumulate shares and then when they’ve accumulated a meaningful amount of shares they transfer them over to their broker account for more control.
In the end it is up to the individual investor to decide what works best for them.
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