The most interesting part of investing (after buying stocks) is probably looking at your portfolio grow. Combine the magic of systematic investing with compounding interest and you get some impressive results. But you can even do more with less. You can grow your portfolio in another way which will completely be free of cash flow from your wallet.
The 3rd magic ingredient to make the perfect investing magic potion is to use the dividend payouts to grow your portfolio even faster. Sorry about the catchy title, but I wanted to find an interesting way to talk about Dividend ReInvestment Plan (aka DRIP).
DRIP While You Are Building Your Portfolio
I think that using DRIP when you are building your portfolio is a very good idea. While your systematic investment plan will serve to buy new stocks, you can grow your position by reinvesting your dividend payouts within the very same shares.
The main advantage of this technique is that you can increase your dividend holdings for almost nothing (some brokers require DRIP setup fees while others offer them for free). When you are starting your portfolio, each penny saved in fees makes a significant difference.
The dividend payouts are not big enough to use this cash to buy another stock right upfront (I suggest a minimum of $1,000 per stock to begin with). So the money will be deposited in your cash account and it will be sitting there for a while earning little to no interest at all. By using a DRIP on your stock, you are able to put your dividend payouts to work the day they are disbursed.
Can I DRIP a Stock that has no or stopped his DRIP plan?
A few weeks ago, a reader (Peter) asked me this question. He was confused as the company he bought had stopped its DRIP plan. He was wondering if he could continue to DRIP this stock by another means.
The answer lies in the type of DRIP. There are 2 types: Traditional DRIP and Broker DRIP. The latter term comes from my own imagination; Questrade calls it a DPP (Dividend Purchase Plan). The traditional DRIP is initiated by the company itself and allows investors to receive shares or fraction of shares in their investing account instead of receiving the actual dividend payout.
However, if a company stops its traditional DRIP, you can also deal with your broker and have it do the same mechanical transaction for you. This means that instead of depositing your dividend payout into your cash account, the broker will use the proceeds to buy more shares of the actual stocks you own and add them to your account. Some brokers may buy fractional shares while others will only buy rounded units and deposit the rest of the money into your cash account.
The main advantage with a “Broker DRIP” is that your firm can do it with all stocks. In fact, it is only up to them to offer a list of stocks. I’ve asked Questrade and they told me that all Canadian Stocks are offered in their Dividend Purchase Plan (how cool is that?). But before running to do DRIPs everywhere, I would first call my broker to know which stocks are available and also read the following:
There are a few situations where DRIPs are not a good idea
As with anything else in the investing world, Dripping is not the solution for everybody and for everything. Here are a few situations where using a DRIP are not a good idea:
a) In an unregistered or cash account (because you have to keep track of all DRIP operations for tax purposes… it’s a pain!)
b) When you have bigger positions in 1 stock (if you have already decided to take a risk and own a bigger percentage in one stock, I doubt that you want to mess with your asset allocation by adding to this position)
c) When you are retired (instead of growing your position, you may want to use the dividend payouts as a source of income instead of generating transaction fees to sell stocks)
d) When you urgently need to buy other stocks (it may be because you want to buy a great opportunity on the market or because you need to revise your asset allocation. But sometimes you need all your cash to buy other stocks in order to build a solid portfolio).
Overall, I think that using a DRIP is another great tool in a complete investment strategy. If you are Canadian and you are looking to use a broker to buy US stocks or make DRIPs, I suggest you take a look at Questrade which offers USD RRSP account and DRIP options on all Canadian dividend paying stocks.
For further reading on DRIP, I suggest the following readings: