DRIP Investing

Dividend Reinvestment Plan investing, or “DRIP” investing, is a very cost efficient way of making passive gains in your portfolio. I have been a big fan of this type of investing for years, as it completely removes two types of investment friction: rounding friction, and commission friction. Well, the second one is a bit of a lie: you are exposed to some commission friction, but it is minimal in the grand scheme of things. But, before I get ahead of myself, I’ll explain what DRIP investing entails.

At its core, a company which offers a DRIP allows the shareholder to re-invest dividends issued by the company directly back into additional shares in the company. So if the share price is $5.00, and you received $10.00 in dividends, you will receive 2 shares. In addition to this core functionality, there may be additional benefits and/or constraints:

Item Description Potential Benefts Potential Constraints
DRIP Enrollment The process of enrolling in the DRIP May have a minimum number of shares required, e.g. you may need 100 shares to even sign up for the DRIP.
OCP/SPP Optional Cash Purchase or Share Purchase Plan. This is the ability for you to buy additional shares directly from the company. May offer a discount on additional shares, e.g. 2% off of the current share price.
  • May have a minimum cash amount required (e.g. $100.00)
  • May charge a small commmission per transaction
Automatic Contributions Automatically debit from your bank account on a periodic basis. This allows you to slowly build your position over time, virtually effort-free on your part. Same as OCP/SPP Same as OCP/SPP

So, how does this all work?

With DRIP investing, you normally have a share of stock in certificated form. Classically, this would mean that you have a physical paper certificate for the company in which you are investing. Today, there are alternatives such as the Direct Registration Sytsem (DRS), but the core of the matter is that the share(s) of the company are registered directly in your name. This differs from a typical stock trade through a brokerage where shares are held in street name (more info may also be found here), where the shares are actually in the name of your broker/agent, and not yourself.

This is important, because once an investment is certificated, you can start participating in the DRIP. You cannot participate in the DRIP if the shares are in street form.

Once you have your certificated share, enroling in the DRIP is as easy as filling out the requisite paperwork.

So, how is this a good thing?

As I mentioned above, one form of friction that DRIP investing eliminates is rounding friction. Recap the example ealier:

[i]f the share price is $5.00, and you received $10.00 in dividends, you will receive 2 shares.

I had picked those numbers for convenience, as they gave us a whole number of shares to re-purchase. However, what if the share price was $7.50, and you received $5.00 in dividends? With a normal brokerage, you would receive $5.00 in cash, and no shares, since the share price is greater than the received dividend. With a DRIP however, you can receive fractional shares. So your $5.00 in dividends will purchase you 2/3 of a share (since $5.00 is 2/3 of $7.50).

Let’s look at OCPs. If you have an extra $100 lying around one day, you might decide to purchase some stocks. Moreover, let’s say you own Telus (T.TO) in your DRIP. The current market price (as of business day close on Sep 9, 2016) is $42.03. If you were to buy shares at a typical broker, assuming $9.95 commission, you could only buy 2 shares, and be left with $5.99 in your pocket ($100.00 less $9.95, and purchasing two whole shares at $42.03). But, because Telus offer OCP/SPP, and no commissions, you can buy 2.379252 shares!

These fracitonal elements are important, because you can now take advantage of true compounding. As an example, let’s use Telus again, with the following assumptions:

  • Share price grows at 3%/year
  • The dividend grows at a rate of $5%/year

At a regular brokerage, after 5 years, here is what you have:

# Numbe of Shares Period Dividend Dividends Received Share Price Dividend Bank Shares Purchased Dividend Bank (end) Net Value
1 1 $0.46 $0.46 $42.03 $0.46 0.000000 $0.46 $42.49
2 1 $0.46 $0.46 $42.34 $0.92 0.000000 $0.92 $43.26
3 1 $0.46 $0.46 $42.66 $1.38 0.000000 $1.38 $44.04
4 1 $0.48 $0.48 $42.97 $1.86 0.000000 $1.86 $44.83
5 1 $0.48 $0.48 $43.29 $2.35 0.000000 $2.35 $45.64
6 1 $0.48 $0.48 $43.61 $2.83 0.000000 $2.83 $46.44
7 1 $0.48 $0.48 $43.94 $3.31 0.000000 $3.31 $47.25
8 1 $0.51 $0.51 $44.26 $3.82 0.000000 $3.82 $48.08
9 1 $0.51 $0.51 $44.59 $4.33 0.000000 $4.33 $48.91
10 1 $0.51 $0.51 $44.92 $4.83 0.000000 $4.83 $49.75
11 1 $0.51 $0.51 $45.25 $5.34 0.000000 $5.34 $50.59
12 1 $0.53 $0.53 $45.59 $5.87 0.000000 $5.87 $51.46
13 1 $0.53 $0.53 $45.93 $6.41 0.000000 $6.41 $52.33
14 1 $0.53 $0.53 $46.27 $6.94 0.000000 $6.94 $53.21
15 1 $0.53 $0.53 $46.61 $7.47 0.000000 $7.47 $54.08
16 1 $0.56 $0.56 $46.96 $8.03 0.000000 $8.03 $54.99
17 1 $0.56 $0.56 $47.31 $8.59 0.000000 $8.59 $55.90
18 1 $0.56 $0.56 $47.66 $9.15 0.000000 $9.15 $56.81
19 1 $0.56 $0.56 $48.01 $9.71 0.000000 $9.71 $57.72
20 1 $0.59 $0.59 $48.37 $10.30 0.000000 $10.30 $58.66

In the above, the “Dividend Bank” is where you would store all dividends received until you had enough to purchase one share, and “Dividend Bank (end)” is the money left over in the dividend bank after buying a share. But, as you can see above, we were never able to purchase any shares! This is because it would take us forever to save up enough of the dividend income to buy a share, plus we have to save up enough to cover the commissions as well.

Using a DRIP, with the same growth assumptions, here is what you have:

# Numbe of Shares Period Dividend Dividends Received Share Price Shares Purchased Net Value % Gain from Without DRIP
1 1.000000 $0.46 $0.46 42.030000 0.010945 $42.49 0.00%
2 1.010945 $0.46 $0.47 42.341740 0.010983 $43.27 0.02%
3 1.021927 $0.46 $0.47 42.655791 0.011020 $44.06 0.06%
4 1.032948 $0.48 $0.50 42.972172 0.011598 $44.89 0.12%
5 1.044546 $0.48 $0.50 43.290900 0.011642 $45.72 0.19%
6 1.056188 $0.48 $0.51 43.611992 0.011685 $46.57 0.29%
7 1.067873 $0.48 $0.52 43.935465 0.011727 $47.43 0.40%
8 1.079601 $0.51 $0.55 44.261337 0.012379 $48.33 0.53%
9 1.091979 $0.51 $0.55 44.589627 0.012428 $49.25 0.68%
10 1.104408 $0.51 $0.56 44.920351 0.012477 $50.17 0.84%
11 1.116885 $0.51 $0.57 45.253529 0.012525 $51.11 1.02%
12 1.129410 $0.53 $0.60 45.589178 0.013192 $52.09 1.22%
13 1.142602 $0.53 $0.61 45.927316 0.013248 $53.09 1.44%
14 1.155850 $0.53 $0.62 46.267962 0.013303 $54.09 1.67%
15 1.169153 $0.53 $0.62 46.611135 0.013357 $55.12 1.92%
16 1.182510 $0.56 $0.66 46.956853 0.014102 $56.19 2.19%
17 1.196612 $0.56 $0.67 47.305135 0.014166 $57.28 2.47%
18 1.210778 $0.56 $0.68 47.656001 0.014228 $58.38 2.77%
19 1.225005 $0.56 $0.69 48.009469 0.014289 $59.50 3.08%
20 1.239294 $0.59 $0.73 48.365559 0.015054 $60.67 3.42%

Where the “% Gain from Without DRIP” is the relative difference between a brokerage-based portfolio and our DRIP. Looking at the above, by using the DRIP, over our 5 year example time horizon we have gained 3.42%, all for doing nothing. And, if you throw OCPs into the mix (e.g. setting up regular contributions), your holdings grow even quicker.

Not all companies offer DRIPs. In Canada, two of the major providers are Computershare Canada and CST (the CST link takes you directly to their DRIP page). But even for those companies that offer DRIPs, not all DRIPs are created equal. Not all companies offer OCP/SPP. Some charge for DRIP, OCP/SPP, and/or withdrawals to/from the plan, and some have minimum balance requirements. That said, when I am looking for a company to DRIP with, other than my regular stock analysis, I look for those who offer and OCP/SPP, and as an added bonus, regular automated contributions by deducting from my bank account. Moreover, those that offer discounts on OCP/DRIP (e.g. Emera which offers up to a 5% discount on DRIP) are even better.

And OCP/SPP is key. The reason being, if you have only one share to start, it will take you forever to get to the point where you can take advantage of material growth through DRIPping.

How does one get started?

You only need one share to start a DRIP, and then you can use an OCP/SPP purchase to purchase any additional shares as needed. You can leverage places such as The DRiP Investing Research Centre‘s Share Exchange board to find individuals who are selling individual shares, or you can even post a message asking for a particular share. Typically individuals selling on these forums ask for a $10.00 convenience fee. This is pretty much in line with most discount brokerages, and since you can easily recoup this cost through the DRIP process itself, it is a small price to pay. Alternatively, you can purchase shares through a regular (discount) brokerage, and then ask the brokerage to withdrawal your shares in certificate form. DRIP Primer has a great list of brokerages, and the fees to do so.

One final thing to mention is synthetic DRIPs. With a synthetic DRIP, a brokerage will buy you any whole shares that it can when the dividend is issued, and any money remaining is given to you as cash. Looking back to Telus, if the share price were $42.03, the dividend were $0.46/share, and you had 100 shares, you would receive $46.00 in dividends. Your brokerge would take this $46.00, purchase one share, and leave the balance ($3.94) in your account as cash. The advantage to this is that the brokerage does not charge you a fee (i.e. commission) for the purchase. The disadvantage is that you cannot take advantage of the fractional shares as with a true DRIP; i.e. you are still subject to rounding friction.

To summarize:

  • DRIPs offer a great way to build compounding returns, through re-investing dividends and purchasing fractional shares
  • Often, companies offer discounts on DRIP and OCP/SPP, but not all DRIPs are created equal; some have better features than others
  • DRIPping does not save you from doing your research: as with all investments, only invest in companies after doing a thorough analysis

And some good resources:

Happy investing!


Yield on Cost vs. Yield on Price? It’s Opportunity Cost that Counts.

I read an interesting article on the Globe and Mail recently, about the “Yield on Cost Myth” (Archived copy may be found at this link). In a nutshell, the author argues that it is erroneous for an investor to consider the yield on cost when they are looking at the dividend yield for a stock; and as a dividend investor this is a very important topic for me. When you are looking at the cash flow stream from an investment, do you look at it from the perspective of what you paid for the stock, or what you would pay today for a stock?

First, some definitions. Yield on Cost is exactly what it sounds like: the total yield returned based on the original cost of the investment. Mathematically:

Yield On Cost=\frac{Dividend}{Average Cost Basis}

This compares to Yield on Price, or what typically we refer to as the normal “dividend yield” of a stock. This is simply the yield based on the current cost of the investment. Mathematically:

Yield On Price=\frac{Dividend}{Current Price}

Now, I do agree that one should focus on the Yield on Price of a stock, not the Yield on Cost of a stock. The reason for this is opportunity cost. Let’s consider the example cited in the original article:

  • You purchased BCE at an average cost of $30.00/share.
  • BCE’s current price is $62.95/share.
  • BCE’s current dividend is $2.73/share.
  • Shaw’s current price is $26.50/share.
  • Shaw’s current dividend is $1.19/share.

Summarizing all of that, let’s do the comparison of the different yields:

 

Company ACB ($) Price ($) Dividend ($) Yield on Cost Yield on Price
BCE 30 62.95 2.73 9.10% 4.34%
Shaw n/a 26.5 1.19 n/a 4.49%

The ACB and Yield on Cost for Shaw are n/a because we don’t actually own them yet. As pointed out in the article, at first glance it makes perfect sense to sell your shares of BCE, and purchase the shares of Shaw, and reap the additional 0.15% yield (which equates to a 3.55% relative gain between yields, since 4.49% is 3.55% greater than 4.34%).

The challenge with this is that it assumes that we live in a frictionless environment. By swapping your BCE shares, you’ll be victim to all at least two, and possibly three, types of friction that I mentioned in one of my earlier posts. Unless you are in a tax-deferred (e.g. RRSP) or tax-free (i.e. TFSA) account, you will be subjected to capital gains tax on the sale of the BCE shares. In addition to this, you will be hit with one, possibly two, commission charges by selling the BCE, and purchasing the Shaw.

However, the biggest challenge is with rounding friction. This is illustrated by the below table, which illustrates the net change in your cash flow stream, based on holding 10, 100, and 1000 shares of BCE:

Activity Scenario 1 Scenario 2 Scenario 3 Scenario 4 Notes
Number of BCE Shares 1 10 100 1000 What you started off with
BCE Share Price $62.95 $62.95 $62.95 $62.95
Shaw Share Price $26.50 $26.50 $26.50 $26.50
Commissions $9.95 $9.95 $9.95 Per trade commission
Proceeds of Selling BCE Shares $62.95 $619.55 $6285.05 $62940.05
Shaw shares purchased 2.38 23 236 2374 Number of shares you can purchase from the BCE proceeds
BCE dividend $2.73 $27.30 $273.00 $2730.00 Net dividend pre-swap
Shaw dividend $2.83 $27.37 $280.84 $2825.06 Net dividend post-swap
Delta $ $0.10 $0.07 $7.84 $95.06
Delta % 3.55% 0.26% 2.87% 3.48%
Implied Delta % 3.55% 3.55% 3.55% 3.55% The relative difference between the Shaw yield and the BCE yield.
Delta Variance (3.29%) (0.67%) (0.06%) How much over or under we are in our real gain in yields, relative to the base case.

Looking at this, you can see that the difference in yield is not necessarily as clear-cut as one would think. Scenario 1 represents the base case in a frictionless environment, and from there we can see that the implied delta, and the actual delta, are equal. However, once we get into the real world (e.g. rounding, commissions), this quickly changes. Looking at 10, 100, and 1000, shares, the actual gain varies. You do come out ahead, but not by as much as the frictionless scenario. Moreover, this example assumes no taxes! When we introduce taxes, things get even worse, illustrated below:

Activity Scenario 1 Scenario 2 Scenario 3 Scenario 4 Notes
Number of BCE Shares 1 10 100 1000 What you started off with
BCE Share Price $62.95 $62.95 $62.95 $62.95
Shaw Share Price $26.50 $26.50 $26.50 $26.50
Commissions $9.95 $9.95 $9.95 Per trade commission
Proceeds of Selling BCE Shares $62.95 $619.55 $6285.05 $62940.05
Tax Rate 16.95% 16.95% 16.95% 2016 Ontario Tax rate for $83M-$86M income tax bracket, from taxtips.ca
Available proceeds to purchase Shaw shares $62.95 $514.54 $5219.73 $52271.71
Shaw shares purchased 2.38 19 196 1972 Number of shares you can purchase from the BCE proceeds
BCE dividend $2.73 $27.30 $273.00 $2730.00 Net dividend pre-swap
Shaw dividend $2.83 $22.61 $233.24 $2346.68 Net dividend post-swap
Delta $ $0.10 ($4.69) ($39.76) ($383.32)
Delta % 3.55% (17.18%) (14.56%) (14.04%)
Implied Delta % 3.55% 3.55% 3.55% 3.55% The relative difference between the Shaw yield and the BCE yield.
Delta Variance (20.73%) (18.11%) (17.59%) How much over or under we are in our real gain in yields, relative to the base case.

Again, with Scenario 1 as our base case (no taxes, no commissions, no rounding), we see that our net gain is exactly 3.55%, which is what we would expect. However, the net result looks gloomier with 10, 100, or 1000, shares: our total income is less after we have made the swap!

At the end of the day, while yield is important, and understanding the difference between Yield on Cost and Yield on Price is important, it is opportunity cost which is the most important. Even though BCE’s Yield on Price was lower than Shaw’s Yield on Price, the cost to make the switch effectively cost us 14% in annualized net income!


Reset button.

It has been a little over a year since my last post, and there have been a number of changes occurring personally, professional, as an investor, and with this site, all of which are intertwined.

The biggest event was that I was displaced in June 2015 due to downsizing at my former employer.  This was a massive hit professionally and financially, as I saw my defined benefit pension fly the coop, and I took a drastic paycut.  The summer of 2015 was a rocky one: instead of going to the beach, enjoying the weather in a park, or drinking on a patio with my mates in Toronto’s downtown core, I was hunkered down at home applying for jobs all summer.  Towards the end of August 2015 I landed a contract position, and from there started up my new life as an independent project management consultant.  So, in the end, things worked out, but it was still a bit of a professional roller coaster; and I will miss the defined benefit pension.

Personally, my family purchased a home earlier in 2016, just ahead of the massive Toronto Housing Bubble.  We lucked out; similar properties in the neighbourhood we moved into have gone up about 10% since we purchased our house earlier this year.  Needless to say, the market is hot, and I am certainly glad not to be part of that fire!

Which brings me to the changes as an investor.  The majority of my investments were being saved for the next big purchase, or retirement, whichever came first.  Needless to say, retirement is a far way off, so I ended up liquidating a number of my holdings to help pay for the house.  While the sting of selling off those holdings is still wearing off, I am happy that overall my previous investment decisions were good ones.  The biggest sale I had which contributed to the house was my long position of CCL Industries, which netted me a tidy return of 517.8%; I had purchased a while back in the high $30 range and sold in the $220 range.  I had some other big gainers (e.g. High Liner Foods returned in excess of 200%), but CCL was definitely my big winner!

Which brings us to today.

With the cashing out of my defined benefit pension, and the selloff of a number of positions in my portfolio, my portfolio has taken a net hit of about 17%.  Moreover, the tax distribution in my portfolio has changed drastically: before all of these major changes, 45% of my portfolio was taxable (i.e. non-registered), and 55% was in non-taxable or tax-deferred accounts, such as an RRSP or a TFSA (i.e. registered).  Now, the mix stands at 10% in the taxable portion, and 90% in the non-taxable.

This split is both good and bad.

The good, is that the majority of my US investments are now in my RRSP – this means I save an instant 15% of withholding taxes, since Canadians do not pay withholding tax on dividends from US corporations if they are in an RRSP.  Moreover, having 90% of my portfolio “locked away” means that I truly am saving for retirement: taking the money out of the registered portions of my portfolio would result in an immediate tax hit.

The bad, is that only 10% of my investments provide present day disposable income.  So, if I need to use any dividend income to offset present day purchases, I am unable to do so.

From a salary perspective, I am not yet at the point where I can pay myself the same salary as before I was displaced, since I have to build up some capital in my corporation.  My salary today is 17% less than one year ago, not including  any short-term bonuses, the losses of which may be even larger.  Contrary to popular belief, independent consultants are not rolling in cash!  Due to this change in salary, I am not able to invest as aggressively as before, which means my portfolio growth will be seriously constrained until I can increase my net cashflow.

As investors, diversification should be one of the primary objectives of our investment portfolios.  I’m happy to report that during the ups and downs of the past 24 months in the markets, my portfolios have done relatively well, all things considered.   With that in mind, the irony of the situation is that my income streams were not diversified.  While I received some income from dividend investing (in 2015, dividends attributed approximately 3% of my net cashflow), like most normal people, the majority of my income came from my place of employment.  So when your job changes, your net income could take a massive hit; such was my case.  With that in mind, I am looking at diversifying income streams as well.

I have moved this blog from a WordPress.com hosted site, to one hosted on my own servers.  This will give me more opportunities for revenue generation through the site; what that means, I am not quite sure, but at least the option is there.  You may see some ads on the site going forward, and clicking through to those will help me in keeping this site on its feet.

I started off by noting that it has been over a year since my last post, and I have a whole slew of ideas and things to write about.  While the original focus of this blog was on dividend investing, I will be branching out into new areas.  From an investing perspective, dividends are typically the payouts a shareholder receives from the profits of the company in which they own shares.  However, a broader definition is “anything received as a bonus, reward, or in addition to or beyond what is expected.”  That said, future posts will also focus on other methods of generating net positive cash flows: this could either be from hard inflows of cash (i.e. income), or cost avoidance, which ultimately results in more disposable income to use in other investing activities.

One thing is certain: I am certainly glad to be back here blogging and sharing my views and ideas, and I look forward to receiving criticism and feedback from my readers.

Welcome back.