Top up the portfolio
Instead of cash, dividend reinvestment plans are a simple and cheap way to add to your holding in a company
Dividend reinvestment plans (DRPs) are an effective means of building wealth over time. They are a great way to boost your holding in a listed entity’s shares and they concurrently add a compounding effect to the wealth you can generate with stocks.
In fact, electing to participate in a listed company’s DRP is almost a set-and-forget way to increase your nest egg. But it is important to understand how they work from a tax perspective, as well as the different types of DRPs, and to keep your records up to date.
> How they work
In a dividend reinvestment plan, a company pays shareholders part of the profits it makes in the form of cash dividends. Dividends are generally paid each year into a shareholder’s bank account in two six-monthly instalments .
“With a DRP, companies offer shareholders the ability to elect to receive their dividends as further shares in the company rather than in cash,” says Dale Gillham, chief analyst for share experts Wealth Within. “It is an automatic reinvestment of the income due to you from the company you own into more shares in that same company.”
You can opt into DRPs at any point 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, says Pete Pennicott, a director of financial advice firm Pekada. “As part of your initial paperwork you will receive 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 DRP. These documents will come via post or email in most cases, and the most efficient way to complete these forms is online via the share registry.”
Similarly, if a company that has not previously had one decides to release a dividend reinvestment plan, then all current shareholders will be notified by letter.
As Pennicott notes, shares are usually issued at current market prices. “Although sometimes they are offered at a discount, so it is always a good idea to read the offer details for each company. Also it is wise to continue to monitor any communication relating to changes to a company’s DRP policy as it can be subject to change and you want to ensure it remains appropriate for your strategy,” he says.
There is no brokerage on the shares you receive through the DRP because you get them directly from the company rather than through a broker or stock exchange.
Once the shares have been issued, the company will send shareholders a statement that details the number of shares purchased, their cost and any residual cash balance to be carried forward.
If the amount of the dividend you are entitled to is not enough to purchase a whole share and there is some residual cash afterwards, it will usually be accounted for and added into the calculation for the next dividend due date.
“Check with the company’s share registry and investor relations as this amount does not always carry forward and in some cases may instead be donated to charity unless you make a proactive election to the contrary,” says Pennicott.
Telstra is one listed business that donates the proceeds of partial shares issued through its DRP to charity.
> Who would benefit
DRPs are prized by most shareholders. But they are especially beneficial for investors who are in the early or growth stage of their portfolio. Smaller investors also benefit as DRPs allow them to compound their shareholding in a company without having to wait to build up the minimum trade size, which in many cases is $500. “They can put their money to work as soon as the dividend is paid,” says Pennicott.
Tony Davison, chief executive and senior financial adviser at Pride Advice, suggests investors view them as a means of forced savings. “But investors who are reliant on dividends to support their cash flow, for example retirees, may prefer not to participate in a DRP and to receive the cash instead.”
DRPs also may not suit investors who want to make proactive decisions on what their next investment will be.
“By electing to participate in a DRP you are unable to purposely make investment decisions
about the best investment opportunity for these funds. While automation has its perks, the problem can be that you have no control on the timing and price of the purchase,” says Pennicott.
> Tax implications
When it comes to tax, DRPs are no different from what the situation would be if you purchased shares directly. But they can complicate an investor’s tax situation.
“When you sell shares, you are subject to capital gains tax on any profits you make,” says Gillham. “The gains are calculated from the time you are allocated the shares. If you have held a share for a substantial period of time, you may have accumulated multiple parcels of shares with multiple purchase dates and various purchase prices through the DRP, all of which have to be accounted for separately with regards to the capital gains tax payable. This can be challenging and time consuming and may add to the cost of accounting fees when submitting tax returns.”
To avoid the headache of retrospectively trying to piece together your transaction records for dividend reinvestment plans, it’s a good idea to record them as they occur, says Pennicott. “It’s so much easier to gather data as the transaction happens, instead of trying to locate the information later.”
The simplest way to record this information is to maintain an Excel or Google Docs spreadsheet saved securely in the cloud. On the spreadsheet, record the dates the shares were issued through the DRP, cost base per share, number of shares purchased, running total of shares and the amount of each dividend. “If you want to take this to the next level, add links to the contract note files, which you should also save securely in the cloud,” says Pennicott.
There are also digital solutions that use data feeds to collate this information. These systems require less human intervention, but come at a cost and give you less flexibility on the way you keep your records.
Pennicott uses Sharesight, which provides a variety of options to meet different investor needs and can even import your trading history into the software. Digital solutions give you a wealth of reporting tools to monitor the progress of your portfolio in addition to the transaction records.
If you want to completely outsource this responsibility, it might be worth exploring options such as wrap accounts, which provide consolidated tax reports. They also bundle the management, reporting and transactions of your investment portfolio, including direct shares, in one place.
“These may require you to change your broker and are suited to investors seeking to hold a variety of different asset types including shares, managed funds, term deposits and cash, while still enjoying a consolidated view and tax reporting,” he adds.
> Check out options
Investors have a number of DRP options. One is minimum participation holdings. “With these, the company may, as part of the conditions of the dividend reinvestment plan, choose a minimum number of shares that a person may elect to receive to be part of the reinvestment plan,” says Gillham. “For example, you must own a minimum of 100 shares in the company.”
Another approach is full or part participation. Under this scenario, investors may have the ability to receive part of their dividend in cash and part in shares through the DRP.
For example, if an investor is due to receive $1000 in dividends and the current share price is $10, then they may elect to receive $500 in cash and 50 shares, which equates to $1000 in total.
The right approach will depend on your own circumstances and investment goals.
> Exit strategies
Investors may exit a DRP at any time by contacting the company’s registrar or visiting the investor area of its website and completing the appropriate documentation.
“If your shares are CHESS-sponsored, that is, held via a brokerage account, you can usually just update your preferences for dividend reinvestment by talking to your broker or through your online login, so it’s very straightforward,” says Canberra-based certified financial planner Michael Miller.
“If you hold your shares individually, which is known as issuer-sponsored shares, you need to provide an instruction for each holding to the relevant share registry. The registries have online logins that can make this a bit easier, but it’s less straightforward than CHESS-sponsored holdings.”
Dividend reinvestment plans offer shareholders a great opportunity to build up the value of their investment over time. If this strategy suits your investment goals, elect to participate in the DRPs of the stocks you hold and watch the number of shares you own rise over time.
DRPs are especially beneficial for investors who are in the early or growth stage of their portfolio