Dividend reinvestment plans (or DRIPs for short), allow investors to use their dividends to automatically purchase additional shares in the same ETF. The arguments in favour of using DRIPs usually go something like this:
- Get more of your money working for you!
- Maximize the benefits of compounding!
- Cut your investing expenses!
Now I doubt anyone will argue with the benefits of reinvesting your dividends over time (rather than spending them). The question is, are DRIPs really necessary or could you just occasionally invest the accumulated cash (especially if you are saving regularly and have to place some trades anyways)?
To help answer this question, I’ve run the numbers to show what return an investor would have earned had they reinvested their dividends from the iShares Core S&P/TSX Capped Composite Index ETF (XIC) at the end of each year, compared to an investor who set-up a DRIP instead.
iShares Core S&P/TSX Capped Composite Index ETF (XIC): 2004-2013
Source: BlackRock Canada data adapted by Justin Bender, CFA, CFP
*Assumes dividends are reinvested on the ex-dividend date at the closing NAV price
In years when market returns were positive, the DRIP investor had higher returns than the non-DRIP investor. In years when market returns were negative (such as 2008 and 2011), the DRIP investor had lower returns than the non-DRIP investor. Over ten years, both investors ended up with about the same return.
Although this is just one example (and does not include the annual $10 trading commission for the non-DRIP investor, nor does it assume they earned any interest from their idle cash), it helps to illustrate the point that investors should be focusing their attention to more important investment decisions that are likely to have a bigger impact on their overall success (such as their savings rate, expenses, risk, fees, taxes and behaviour).
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We’re considering moving our TFSA out of Mutual Funds into Direct Investing and putting the funds into ETFs instead. I thought that this would only make sense if the ETFs are DRIP eligible, so that the dividends are compounding tax free. Is this correct or am I missing something? Unfortunately the VCNS is not eligible with RBC Direct Investing.
@Beth: You definitely want to reinvest your dividends at some point, but it doesn’t have to be an automatic process. You can simply just place a trade once a year to buy more units of your asset allocation ETF with any distributions paid in cash into the account.
You’re missing part of the benefit of DRIPing. If you reinvest dividends with companies directly, you often do so at a discount. This increases your compound growth, and over a long term provides a greater edge for DRIP investors.
I am trying to get into DRIPing. Is there any advice you could give me? Any books to help? Thanks
Two of the reasons that I like to NOT DRIP are the following:
– I typically have a very low cash position in my overall portfolio, so the dividends as cash actually give me some.
– Secondly I find that accumulating the dividends help me easily manage my yearly re-balancing, i.e.: I typical have less to sell, because I have cash on hand.
I’m a DRIP’er like Mark. I like the simplicity of DRIP and it allows me to cost average.
@Tawcan – how could I argue with a fellow Tool fan? ;)
I used to use DRIPs, but now I use my dividends in my RRSP and TFSA to balance my portfolio by purchasing ETFS that have lagged behind my targeted proportion. Since I use Questrade, I do not pay to buy ETFs; by rebalancing with DRIPs it helps to avoid selling my successful ETFs when I would have normally rebalance at the end of the year. As Questrade does charge for selling ETFs, this method also saves me fees.
Is there any advantage of a dividend specific ETF being enlisted in a DRIP? Wondering if you could run the same numbers for say CDZ?
@CD – in up markets, I would expect running a DRIP on a dividend ETF would lead to larger relative outperformance than a market-cap weighted ETF (vice-versa during down markets). In the end, the result will depend on the future market returns – but I wouldn’t expect there to be a significant difference between either running a DRIP or not running one over the long term (as long as you occasionally invest the cash dividends manually).
Okay, that makes sense, I figured they would be negligible in the long run. Thanks for the reply.
Very interesting outcome-not what i would have expected.
Being a DRIPper myself Justin, anything that takes my hand off the wheel and stops me from tinkering with my portfolio is a good thing. DRIPs are excellent for that :)
@Mark – another great point. If DRIPs help you tinker less with your portfolio, than DRIP away ;)
One thing that should be noted is that drips are great when reinvesting dividends in registered accounts (TFSA and RRSP) where an influx of money happens only once a year.
@Rich – good point (especially since you don’t have to worry about tracking your adjusted cost base in these types of plans).