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The DRIP Myth

December 5, 2014 - 10 comments

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 invested 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.

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).

By: Justin Bender with 10 comments.
Comments
  26/10/2017 9:28:56 AM
Justin bender
@invest: The analysis is for a single investor.
 
  17/10/2017 3:44:22 PM
invest
Do you mean one person or more than one?
The sentence is not clear as you have AN and THEY:
I’ve run the numbers to s how what return AN (singular) investor would have earned had THEY (plural) invested their dividends ...
 
  06/02/2015 10:13:23 AM
Justin Bender
@Kathy - the main point of the article is that while it is necessary to reinvest the dividend income at some point, how this is done is really an administrative question (and not meant to be a return enhancer).
 
  06/02/2015 10:10:16 AM
Justin Bender
@Gordon - it's correct. Let's assume your annual income return is $270 on a $10,000 investment (or 2.7%....$10,270/$10,000 - 1). If you reinvest the $270 at year-end and pay a $10 commission, you would be left with $10,260 ($10,270 - $10,260), for an income return of 2.60% ($10,260 / $10,000 - 1).

2.60% minus 2.70% equals -0.10% drag.

The analysis assumes only 1 reinvestment at year-end, so a stock that pays monthly dividends is irrelevant. The cash would accumulate throughout the year, and a single trade would be placed at year-end.
 
  06/02/2015 8:53:43 AM
Kathy
Have you looked at only putting drip on stocks with dividend re-invest discount? Emera for instance has a 5% discount. I put drip only on the stocks in my portfolio that had a re-invest discount; it was about 1/3. I would be interested in an analysis using only stocks with DRIP discount
 
  16/01/2015 6:57:29 PM
Gordon
That's incorrect. Let's say the dividend yield averages 2.7%. That's $270 in year 1 on a $10,000 investment. The impact is 3.7%. The lower the initial investment, the larger the impact. The lower the initial investment, the larger the impact. Also, many stocks pay monthly dividends, which would again, have an impact
 
  05/01/2015 9:48:52 AM
Justin Bender
@Mike03 - I considered including a $10 commission per year, but this would not have had much impact on the results (approx. 0.1% on a $10,000 investment and 0.01% on a $100,000 investment).

If you have run the same type of DRIP analysis on your stocks over the past 10 years, please feel free to post the results.
 
  31/12/2014 2:16:55 PM
MikeO3
Not sure why you would not include the trading commissions... Is that the point of showing the returns comparison overtime of a DRIP purchase versus a commission based purchase? (Albeit there are commission free brokers you could argue but I think it would be valuable to include in your discussion)

Also, if one were to evaluate and compare DRIP's in non-index based investments I can attest that my long term topsy turvy investments in HPQ, INTC, AQN and CSW.B DRIP's have certainly been great DCA examples on how DRIPS work well overtime.
 
  31/12/2014 1:06:49 PM
Rob
I think a DRIP account benefits those who are poor at saving and/or lazy investors. Anyone else--presumably the majority--would see little benefit over the long term. Excellent article, Justin!
 
  31/12/2014 8:46:32 AM
David Little
Even if, as you say, the net benefit is zero in the longer term, DRIPs do help to keep you invested, and avoid having idle cash sitting around too long (especially valuable for couch potatoes). Not to suggest DRIPs are always right - I am retired and cancelled my DRIPs to fund RRIF payments.
 



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