Reap the re­wards of com­pound­ing

The Weekly Advertiser Horsham - - News -

The real power of in­vest­ment comes from com­pound­ing re­turns – the process of putting your in­vest­ment in­come straight back to work so it can earn more in­come.

To help their in­vestors reap the re­wards of com­pound­ing, many com­pa­nies of­fer div­i­dend rein­vest­ment plans, DRPS.

Un­der a DRP, in­vestors can choose to use some or all of their div­i­dends to au­to­mat­i­cally pur­chase ad­di­tional shares in a com­pany.

As a sweet­ener, in­vestors avoid brokerage, and some com­pa­nies even of­fer a dis­count on the share price.

This means that div­i­dend pay­ments are work­ing to earn new div­i­dends rather than lan­guish­ing in low-in­ter­est bank ac­counts.

Par­tic­i­pants in DRPS can also ben­e­fit from dips in the mar­ket.

When prices are down, a given div­i­dend amount will buy more shares than when prices are high.

How­ever, be aware that it is en­tirely up to each in­di­vid­ual com­pany’s man­age­ment to de­cide whether or not it will of­fer a DRP, and that the plan can be sus­pended or al­tered at any time.

Who might DRPS suit?

DRPS are suited to in­vestors who do not need the in­come and who are seek­ing to max­imise the growth of their port­fo­lio. They can also be good for ‘lazy’ in­vestors.

After the nom­i­na­tion to par­tic­i­pate in the DRP is made it hap­pens au­to­mat­i­cally with each div­i­dend pay­ment: no fur­ther ac­tion re­quired.

That said, DRPS can gen­er­ate a lot of pa­per­work. Each pur­chase is a sep­a­rate event with its own cost base for Cap­i­tal Gains Tax, CGT, pur­poses, and its own start date for the CGT dis­count.

DRPS are not suited to re­tirees and peo­ple who are draw­ing down on their port­fo­lios and de­pen­dent on all the in­come it can pro­duce.

Don’t for­get the tax

With a DRP the div­i­dend never hits your bank ac­count, but that doesn’t mean you haven’t earned it.

It still needs to be de­clared as in­come on your tax re­turn, along with its as­so­ci­ated frank­ing cred­its – the tax al­ready paid by the com­pany.

De­pend­ing on your mar­ginal tax rate, the frank­ing credit might be suf­fi­cient to cover any tax payable on the div­i­dend, or you might even re­ceive a refund.

If not, you will need to pay some ad­di­tional tax, so be pre­pared for this.

Al­ter­na­tives to DRPS

DRPS can be good for in­vestors who have a pos­i­tive view of the com­pany they own shares in and are happy to in­crease their hold­ing in it.

Of course, if the com­pany turns out to be a dud, par­tak­ing in a DRP will mag­nify the ul­ti­mate losses. An al­ter­na­tive is to take cash div­i­dends and reg­u­larly ap­ply them to pur­chas­ing other as­sets.

This can still pro­vide the ben­e­fit of com­pound­ing while cre­at­ing an op­por­tu­nity to fur­ther di­ver­sify and re­bal­ance the port­fo­lio.

Div­i­dend Rein­vest­ment Plans can be an ef­fec­tive part of an in­vest­ment growth strat­egy.

The qual­ity of the com­pany of­fer­ing the plan is para­mount, but record keep­ing and in­come re­quire­ments also need to be man­aged.

Your fi­nan­cial ad­viser will be able to fur­ther ex­plain the po­ten­tial pros and cons of DRPS and help you de­cide if they are right for you.

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