The Hidden Benefits Of Zero | Should You DRIP Your Dividends?
When you first get initiated into the dividend growth investing cult, one of the things you need to figure out is what to do with all of those dividends. If you're in the withdrawal phase then the answer is simple take the dividends to fund your lifestyle. However, if you're in the accumulation phase, then you have to figure out whether to DRIP or not.
What Is A DRIP?
DRIP stands for dividend reinvestment plan and is offered by most brokerage firms to allow you to automatically reinvest the dividends back into the companies that paid them.
The other option is to take the dividends in cash and just pool it with additional savings and investment capital whenever you're ready to make another purchase.
There's no right or wrong answer as to DRIP-ing your dividends or pooling them. It really comes down to personal preference.
The main advantage of DRIP is that it's automatic. Why wouldn't you want to increase your stake in a business that you believe to be high quality?
The big disadvantage of DRIP is that you're valuation agnostic. In other words, whenever the dividend gets paid out it's automatically reinvested without regards to the valuation at the time. Over the long run that's probably not a big issue because business valuations aren't likely to be to exorbitantly mis-valued on the average assuming a long holding period.
My usual recommendation is that it depends on what your financial situation is like. For an account like an IRA I think DRIP is the best way unless you're having serious amounts of dividends come in on a monthly or quarterly basis.
I also recommend DRIP if you're not able to consistently push new savings to your brokerage account to invest. If you're only able to move funds to invest sporadically then I think DRIP is best to keep the compounding going.
However, if you're in the situation where you can save and invest each month then pooling probably makes more sense.
That's the general guideline that I follow for my own investment accounts, although I do have the DRIP turned on for positions that I want to build up over time.
DRIP In Action
Let's take a look at one of the quintessential dividend growth stocks: Johnson & Johnson. If on January 3, 2000 you invested $10k to get a stake in Johnson & Johnson you'd have been able to purchase a split-adjusted 216.97 shares at $46.09 per share. Here's the results as calculated by Dividend Channel.
For the non-DRIP scenario you'd have received $8,696 in dividends and still have your original 216.97 shares valued at $38,647. That's a 286.5% total return or ~7.0% per year. At the current quarterly payout of $0.95 per share your position could expect to produce $824.49 in annual dividends thanks to the steady dividend growth Johnson & Johnson has provided.
However, if you had diligently re-invested the dividend payments in those nearly 20 years you'd now own 357.98 shares valued at $49,413. That pushes the total return up to 394% or ~8.4% per year. In this scenario your forward dividends from Johnson & Johnson would be $1,360.32 or ~65% higher because of the DRIP and boosting your share count.
There's no doubt that turning the DRIP on is a boost to your returns. Although it's not an apples-to-apples comparison because in reality you're still re-investing those dividends while in the accumulation phase, just into other investments.
The Hidden Benefits Of Zero Commissions
In October, the calculus changed a bit with regards to DRIP. The brokerage firm Interactive Brokers announced they were introducing a no commission version of their platform and Schwab quickly followed suit reducing their commissions to $0 as well. That sparked a race by just about every major brokerage firm in the United States to lower their own commissions to $0.
Now that the norm is $0 commissions for US-based investors, the question now is does it make sense to DRIP?
The biggest deterrent against pooling the dividends rather than DRIP, especially if your monthly investment capital was sporadic, was commissions. It doesn't make sense to re-invest your $20, $30 or even $200 dividend at a $5 commission. In gambling terms, there's too much rake.
However, with $0 commissions taking all dividends in cash and re-investing them into your best ideas, best valuations or just positions you want to build up could very well make a lot more sense. It's definitely economically feasible to do so now.
What you're giving up by doing that is the hands-off approach of just clicking a box and having the broker do it for you. There's always a give and take. Of course that could be made up for by getting better value for your dollars.
I don't think either approach is bad here whether you collect your dividends in cash or automatically DRIP them back into more shares. The $0 commissions definitely evened the playing field and makes the decision less black and white and much more gray.
I've since turned off the DRIP on some of my positions, although I still have it on for a large portion of my holdings, especially in my taxable account.
Over the coming weeks and months I'm sure to ponder more on whether to keep the DRIP on or off. Although I'm very much leaning towards turning it off for a majority of my positions.
Do you DRIP all the dividends you receive or take them in cash? Has the $0 commission made you re-think that decision?