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Howdy all!
Whoa, freezing me proverbials off here in Old Sydney Town at the moment, hope you guys are staying warm!
I’m looking forward to next week, as it’s a well-deserved week off work to have some much needed R’n’R.
When did life become so stressFUL these days, geebers.
Mind you, would have liked to travel somewhere, say the Bahamas… but with COVID raging on, of course that’s not possible.
I was actually searching where to go during my week off when an email notification popped-up about a dividend reinvestment plan approaching for one of my shares in the portfolio.
What is a dividend reinvestment plan?
I’m so glad you asked!
Because, it’s the topic of today’s post.
You see, when a company (or ETF) makes a profit, they can elect to reinvest that profit back into the company OR distribute some/all of that profit in the form of dividends.
How they distribute the dividends is very important.
Most companies (and ETF’s) choose to distribute those dividends in the form of cash – this is what many retirees and FIREees live off.
However some companies (and ETF’s… you know what, when I say companies, I’ll mean both companies and ETF’s… saves me typing “and ETF’s”).
Like I was saying… some companies allow you to choose whether you want to receive those dividends in the form of cash OR further shares (or units) of that company (or ET… you know what I mean).
Why do it?
Good question.
A DRP is an automatic reinvestment of the income due to you, into more shares of that same company.
There is also usually no brokerage on the shares you receive through the DRP because you get them directly from the company rather than through a broker or stock exchange.
DRP are highly prized for those of us early on in our investing careers, because it allows us to compound our holdings.
This is why I do it, and personally – why I think it is a no brainer if you’re starting out building a portfolio.
How so?
Ok, well for example let’s say you have 1,000 ABC shares at $1 and ABC has a 10% dividend payout ratio or $100.
This is what you will receive if you participate in the DRP:
As you can see, the compounding effect allows you to grow the portfolio organically – without any transaction on your part.
Of course, the stock price fluctuates over time and the dividend payout ratio is subject to change as well.
Also be aware that there are no partial shares that are issued, check with the share registry or company itself regarding how partial cash is treated.
Still, it sounds great! How do I do it?
I know right! Well, when you buy shares in a company or units in a fund that offers a DRP, they will usually contact you either via email or post, and ask whether you wish to participate in the plan and advise you on how to go about doing so.
Most cases, there is a simple DRP form you need to complete and return to the share registry (like Computershare or Link Market Services).
A share registry is a financial administrator for each company/fund. Every company/fund’s registry is different but Computershare and Link are two of the biggest.
Or you can just change it online.
Here is a screenshot of where to find it on a share registry, in this case Computershare:
I have blacked it out, because well er… those are my personal details.
Also note that this particular holding of mine does not allow a DRP – crafty buggers. I wanted to show you guys this as a reminder not every company does it.
However my own personal favourite with DRP is that I invest in direct shares via my superannuation, which has a set-and-forget kind of setup:
And a couple of clicks later… hey presto:
Amazing, what else should I know?
Hm… well I think there are a couple of things to watch out for.
Firstly, a DRP is never guaranteed, as I have mentioned before, the company or fund can change how they pay their dividends (or scrap them entirely).
Also, did you know that you can also choose to only partially participate?
For example, if you are entitled to $1,000 of dividends and the current share price is $10. You can elect to receive $500 in cash and 50 shares, which equates to $1,000 in total.
And the tax treatment is a bit tricky, as any gains are calculated from the time you are allocated the shares.
So if you have held a share for a substantial period of time, you may have accumulated multiple parcels of shares with multiple purchase dates and various purchase prices through DRPs.
These all have to be accounted for separately with regards to the capital gains tax payable when you sell.
Always, always check with your accountant or financial adviser before making any financial decisions.
And of course, the most important consideration.
If you need cash or are reliant on income to survive, think twice whether you’d prefer cash or additional shares/units.
Apart from these, I still think DRP’s are an amazing and simple strategy to get ahead. What about you?
Let me know in the comments below!
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