What you need to know about dividend reinvestment plans (DRIPs)

What are they and how are they offered?

Dividend Reinvestment Plans or DRIPs are offered by some companies to facilitate using the money you would usually receive in cash to purchase additional shares in the company. In simple terms you give up the cash benefit and opt to accumulate more shares in the company.

You can generally opt-in to DRIPs at any point given enough time before the record date for the upcoming dividend and your first opportunity to participate is at the time of your initial investment in the company. As part of your initial paperwork, you will get your contract notes and forms which provide the option to nominate a bank account and receive the dividend as cash, or alternatively to participate in the DRIP. These will come via post and email in most cases, with the most efficient way to complete this is online via the share registry.

The main advantage is that it compounds your returns as you are automatically reinvesting your earnings. It is also a very good form of forced savings and this happens on auto-pilot until you turn it off.

Shares are usually issued at current market prices but sometimes offered at a discount so it is always good to read the offer details for each company. Also, it is wise to continue to monitor any communications relating to changes to their DRIP policy as it can be subject to change and you want to ensure it remains appropriate for your strategy.

Another benefit is that shares acquired through the DRIP do not have brokerage or transaction costs, which is of particular benefit for smaller shareholders where this cost would be proportionately large. There are no minimum amounts required to participate which when compared to minimum trade sizes that apply to purchasing shares directly provides access to more investors regardless of the size.

Once you receive the payment, the company will issue a statement that details the number of shares purchased, the cost and any residual cash balance to be carried forward. This cash balance carried forward is a result of DRIPs requiring the purchase of full units of shares, so there is generally change leftover and in many cases carries forward and is added to the next dividend and combined with this amount to purchase more shares. Definitely check with the individual company’s share registry and investor relations as this amount does not always carry forward and in some cases is instead donated to charity unless you make a proactive election.

Best practice is to file this along with your contract notes so that you have all of the information required to prepare your tax returns when required.

What types of investors would find dividend reinvestment plans useful?

DRIPs are best suited to investors who are seeking to grow their portfolio and want to automate as much of the investment management as possible. It provides a simple and friction-free way to compound your investment income into more growth assets for a company that you already have conviction in.

Smaller investors are also benefited as it allows them to organically compound their shareholding in a particular company without having to wait to build up the minimum trade size which in many cases is $500. Instead, they can put their money to work as soon as the dividend is paid.

It’s unlikely that retirees or income investors who require the income to fund their expenses would opt for a DRIP, as it wouldn’t provide them with the cash returns they require.

This would also not suit investors who want to make proactive decisions on what their next investment will be. By electing for a DRIP you are unable to purposely make investment decisions about the best investment opportunity for these funds. My personal preference is to actively use the cash funds to purchase what I feel is the best investment at the time and not simply continue buying the same shares because of a dividend. Whilst automation has its perks, the problem can be that you have no control on the timing and price of the purchase.

What are the tax implications (if any) of using a dividend reinvestment plan?

You still have to pay tax on the dividend. You don’t receive the physical cash, but in the eyes of the ATO, you still have to pay tax on this amount in the financial year you receive it. As the funds will be instead invested into more shares in the company with a long-term view, you need to ensure you have the cash available elsewhere to pay these tax liabilities without having to sell the shares.

One of the biggest frustrations with DRIPs is messy record keeping due to the volume of transactions over the years, as each individual parcel of shares will have a different purchase price/cost base. As shares are generally a long-term investment you can imagine the number or individual parcels of shares that accumulate over the years. This shouldn’t be a difficult assignment, but it is tedious and is much easier to maintain if you update your records as the transactions occur.

Good records which detail each tranche of shares purchased via a DRIP is particularly important when selling part or all of your holding in a company as you will need to calculate your cost base across all holdings for CGT purposes.

How can investors best keep on top of the tax implications on their DRP shares? Is there any software or other tools?

To avoid the headaches of retrospectively trying to piece together your transaction records for dividend reinvestment plans it is advised to keep these up to date as they occur. It is significantly easier to gather data when the transaction is recent, as opposed to trying to locate this information several years, email addresses and home addresses later!

In terms of tools, the simplest and still effective way is to maintain a spreadsheet either on excel or google sheet saved securely in the cloud. I would suggest that saving this online in the cloud is a more sustainable long-term solution as share investments tend to last years and you will likely be upgrading your computer over the journey, so you don’t want to risk having the data saved locally to your hard drive and having to start all over again. Your spreadsheet should contain important information which you will require in the future including dates, cost base per share, number of shares purchased, running total of shares and the total amount of the dividend. If you want to take this to the next level then you can also add links to the contract note files which you have also saved securely in the cloud as part of your record-keeping.

If you want something more automated then you could review one of the many digital solutions which use data feeds to collate this information. These are great and require less human intervention, but do come at a cost and give you less flexibility on the way you keep your records. In most cases you won’t be required to change your preferred broker and simply provide the necessary information to set up the data feed so they can get the information from your share trading account directly ongoing. I have personally used Sharesight which provides a variety of plan options to meet different investor needs and can even import your trading history in many cases (https://www.sharesight.com/au/). The advantage of digital solutions is you get a wealth of additional portfolio reporting tools to monitor the progress of your share portfolio in addition to the transaction records.

If you want to completely outsource this workload then it may be worth exploring options such as wrap accounts which provide consolidated tax reports and bundle the management, reporting and transaction of your investment portfolio including direct shares together in one place. These require a change from your current broker and would be more suited to investors seeking to hold a variety of different asset types including shares, managed funds, term deposits and cash whilst still enjoying a consolidated view and tax reporting.

Are there options within dividend reinvestment plans?

In most cases, you can also nominate whether all or just part of your shareholding is part of the dividend reinvestment plan. The residual amount leftover after as many full units of shares are purchased via a DRIP can come with several options and the default may not be your preference. The most common default action is that the cash balance is carried forward and is added to the next dividend and combined with this amount to purchase more shares. Definitely check with the individual company’s share registry and investor relations as this amount does not always carry forward and in some cases is instead donated to charity unless you make a proactive election which is the case with Telstra for example.

How can you exit a dividend reinvestment plan?

Exiting is simply actioned via the share registry. If you are unsure who this is for your company then you should be able to locate this information on the company website in the investors section.

The wrap

In summary, DRIPs are a simple way to compound your investment income returns. Whilst they aren’t for everyone, I can see that they have a place in the right portfolio and in particular for smaller holdings where the cost of brokerage is a proportionately higher consideration. If you do decide to participate in a DRIP then please heed my warning and keep very detailed, neat records… you will be thanking me later when the time comes to calculate your cost base following a sale!

As always please contact me to discuss any queries or specifics relating to your situation at connect@pekada.com.au

Thanks for reading.