How to Complicate Dividend Reinvestment.
Earlier this year, when Blackrock Barclays, distributors of iShares Exchange Traded Funds (ETFs) in Canada, announced monthly (instead of quarterly) distributions of income for 11 of their Canadian ETFs, it made the job of reinvestment a little bit more complicated.
But, now with monthly income distribution, there are fewer dollars to buy each additional share. And because most brokers will only buy round or whole (no partial) shares, fewer shares get bought and reinvested each month and there is more idle cash left … well, idle.
For example, if the dividend is $27 and the share is trading at $20, a DRiP will buy one share … and the remaining $7 will be paid in cash. (Previously, with quarterly distributions, more whole units were bought and there was less idle cash. One share bought monthly does not equal three per quarter. In our example the investor buys four shares per quarter, 3 x $27 = $81 = 4 shares plus $1 idle cash).
Too bad because, today, idle cash pays little or nothing.
What can an Individual investor do?
DRiPs are still a powerful portfolio management tool.
Income and dividend reinvestment (DRiPs) can be thought of as a forced saving program. So, 100 shares become 103, then 107 and so on as distributions of income or dividends get reinvested … automatically … commission free … into additional units. Over time, the reinvested distributions compound (compounding is good) and the number of shares owned grow as income and dividends do. Further, because reinvestment is automatic, DRiPs remove emotions from the ‘when to buy’ decision and automatic reinvestment means a temporary market correction can work in the investor’s favour.
DRIPs can also be thought of as a form of Dollar-Cost-Averaging (DCA).
DCA is an effective strategy for all markets but it is especially well suited to volatile markets. (The more volatile the markets, the better). Rather than trying to decide when to buy, automatically reinvesting on a regular basis through DRiPs, means buying more shares when prices are down and fewer when prices are higher … automatically. Over time, costs average out and tend to flatten market volatility. There is no second-guessing, no emotion and no attempt to time the market. It’s like automatic payroll deduction for your investments.
DRiPs can also be used in conjunction with a Rebalancing strategy.
Rebalancing moves money from an asset class that has done well and may now be overvalued and then reinvests into an asset class that has not done well and may now be undervalued. (Sell high. Buy low). When a portfolio drifts away from the investors intended target allocation between stocks, bonds and real estate, say, the risk characteristics of the portfolio change and it may not deliver the desired return results. Rebalancing, on a regular basis, helps to ensure that when market extremes are reached portfolio holdings are sold at a high and bought at a low ‘before’ they correct back to longer term averages. In this way, rebalancing smoothes the highs and lows while contributing to performance.
DRiPs, however, don’t sell shares. Rather, DRiPs continually accumulate more shares. It’s the idle cash remaining from the income distributions that can’t be reinvested that can instead be used to rebalance.
DRiPs, DCA and Rebalancing remain three of the most powerful risk and portfolio management tools available to any investor.
(It’s understandable why iShares made the switch to a monthly payout. Retiring Baby Boomers want monthly income. And there are more Baby Boomers than there are investors still accumulating wealth. Call it the law of unintended consequences).
Doug Cronk CFA is Manager, Investments for a Canadian Pension Plan