Should I reinvest my dividends?

For many investors, dividends are a great source of income, whether it be for paying the bills, going on a holiday, or spending it on whatever you choose.

However, some companies offer shareholders the opportunity to participate in a Dividend Reinvestment Plan (DRP), which allows the shareholder to use all or part of their dividend to receive new shares in the company.

DRPs are a great way for investors to build their wealth, as they allow the compounding effect to occur. DRPs also benefit the company, as it allows the company to retain cash to help grow profits.

Example of a DRP

Maria owns 5,000 shares of company ABC, and the company declares a dividend of 20 cents per share fully franked. The company has calculated that the DRP Share Allocation Price is $5.00 (based on an average weighted sale price of ABC shares during the relevant pricing period).

If Maria chooses not to participate in the DRP, then she will receive a cash dividend of 5,000 x $0.20 = $1,000.

If Maria does choose to participate in the DRP, then she will receive $1,000 / $5.00 = 200 new shares. The number of shares Maria now owns in ABC is 5,200.

In both scenarios Maria will need to include her dividend and the franking credits in her tax return.

DRP Participation

DRPs are currently available across many ASX companies including BHP (ASX: BHP), Commonwealth Bank (ASX: CBA), ANZ (ASX: ANZ) and Telstra (ASX: TLS).

For those companies that do have a DRP, there may be times when the DRP program is temporarily (or permanently) suspended. If this occurs, the company will advise its shareholders and explain the reason why.

When purchasing shares for the first time in a company that offers a DRP, a shareholder will receive from the company instructions on what they need to do to participate. Often the company’s website will also provide instructions on what a shareholder must do to participate in the DRP.

So, the big question is, is it best to receive the dividend in cash, or receive new shares via a DRP?

The answer to this depends on you and your situation. If you need the income, then taking the cash dividend makes sense. If, however you don’t need the cash and want to build your shareholding and wealth, then the DRP is worth considering.

Either way, here are the Pros and Cons of Dividend Reinvestment Plans:

Pros

1. DRPs are a great way to compound your wealth. If the number of shares you own is growing, and the share’s dividend is also growing, then over the long-term this magnifies your total dividend and your wealth.
2. Dollar Cost Averaging. DRPs allow investors to use their dividends to regularly invest into the market, often biannually. This helps to spread out purchases across both the highs and lows of the market and takes the risk out of trying to time the market.
3. No brokerage fees. Unlike shares bought on the open market, DRPs do not attract brokerage fees. Though these fees may not appear much, over time the savings do add up.
4. Possible discount. As part of the DRP, some companies offer the new shares at a slight discount, generally in the range of 1% to 5%.

Cons

1. By utilising a DRP, it will mean that you miss out on the dividend cashflow. If you rely on this cashflow then a DRP may not be the best option for you.
2. Dividends are still subject to tax. When you receive shares via a DRP, the transaction is treated as though you received a cash dividend and used it to buy more shares. Hence the dividend and any accompanying franking credits must still be included in your tax return. The new shares received via the DRP will also be subject to capital gains tax when they are sold down the track.
3. If the company offering the DRP is not a great stock, then accumulating more shares in the stock may not be the best strategy. An alternative is to take the dividend as cash and then buy into a better investment.
4. Paperwork can be more complex. When an investor participates in a DRP over a long period of time, they are effectively on each occasion, buying new shares in the company at a given price. This means that when selling those shares, each individual DRP transaction will need to be itemised so that the cost base for each transaction is calculated correctly. This ensures the capital gains tax is correctly calculated.
5. DRPs may create an unbalanced portfolio. If the company that is offering the DRP is the biggest position in your portfolio, then adding more stock via a DRP will make the position bigger. An alternative is to take the dividend as cash and then buy into another high-quality stock to help balance your portfolio.

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