Dividend Reinvestment Plans (DRP) provide shareholders the opportunity to reinvest all or part of the dividend they receive from a company into further shares in lieu of cash. This reinvestment occurs without transaction or brokerage costs normally associated with an investment in a company. Sometimes these plans are even offered at a discount to the shareholder, allowing the reinvestment to be made for slightly less than the trading price.
Advantages of participating in dividend reinvestment plans
Whilst companies are not required to offer DRP plans to shareholders (or pay dividends for that matter) they do offer certain advantages to participating companies. They are an effective capital management tool for the company, allowing for the company to retain capital through issuing shares rather than additional debt. From a participating shareholders point of view, there are numerous potential advantages that market participating in a dividend reinvestment plan attractive. These include;
- Additional shares purchased through the DRP incur no brokering costs on the purchase;
- DRPs traditionally suit the ‘sit and forget’ strategy. Benefiting from the compounding of your initial investment your initial investment can growth through the contribution of the dividend payments; and
- In some cases, there is the benefit of the dividends being reinvested at a discount to the market price of the company’s shares. This will be stated by the company generally prior to the announcement of the dividend.
Disadvantages of dividend reinvestment plans
Unfortunately, for some investors, there are disadvantages that need to be considered before participating in DRPs. These disadvantages include but not limited too;
- Additional shares being purchased without any control of price paid. When the share price is ‘depressed,’ investors can potentially pick up a bargain. In contrast, however, when the share price has run up strongly the share price is then potentially expensive.
- Major shareholders reinvesting could see your holding diluted further regardless of your participation. If major shareholders are participating in the DRP, then they will dilute shareholders who are not.
- Companies can also suspend DRPs without warning or choose to limit the number of shares available to those participating in the reinvestment plan.
Regular rebalancing of portfolio required
DRPs can potentially see the increase in the need for the rebalancing of your portfolio as over time. The addition of extra shares can lead a portfolio being miss aligned with the investors strategy. Rebalancing the portfolio(s) at these events or at a set time/date should reduce the risk that is potentially posed to investors in this scenario.
Lastly, investors have to consider the tax implications that they will incur if they choose to participate in the dividend reinvestment plan.
Investors remain able to continue to receive franking credits when participating in DRPs. Importantly, capital gains tax (CGT) for participants is treated as if you had received the dividend as cash and then used those funds to purchase additional shares. The cost of each share purchased through the plan is determined by the price of the share at the time of the dividend period.
Dividend Reinvestment Plans: In summary
Dividend reinvestment plans will remain an attractive investment for some investors while for other investors the idea of dividend reinvestment will not come into consideration.
DRPs suit investors that have a high conviction in their investment and are not influenced by the repurchase price of which the additional shares are being acquired for. It essentially means that investors are not required to make a decision on what to do with dividends that they would usually receive in cash.
Of course, participation in these plans should ideally only occur in fundamentally healthy companies and the additional paperwork (important come tax time!) being accounted for with a portfolio management tool, such as Stock Doctor’s Portfolio Director.
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