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:
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).