I will always argue that Canadian investors simply love their dividends. What is my proof, you might ask. We’ve noticed that every time we discuss income, or dividends, we get far more engagement from our readers than almost any other topic. Which is why I thought to ask a few of my friends and family what they do with the dividends they earn.
Some said they use it for their day-to-day living expenses (the investors who said this tended to be those without a steady paycheck, or those in retirement) while others said they use it to “treat themselves” as it was free money (this sentiment was expressed by those who invest while also working,) while others said they just let them accumulate.
I asked all of them if they considered DRIP investing, and a majority had no idea what I was talking about. So today, let’s talk about DRIP investing – the unsexy strategy with a name that recalls annoying faucets, but what is in reality a secret wealth builder.
What is DRIP Investing?
DRIP investing is an acronym that stands for Dividend (or Distribution) Re-Investment Plan. If you own a stock, or an exchange traded fund (ETF) that pays out distributions or dividends, chances are you get this money on a specific cadence. Some pay out the dividends on a quarterly basis, while others pay them out annually. Some, like the Harvest Diversified Monthly Income ETF (HDIF) pay out income monthly. Whatever the payout cadence, the distribution or dividend will land in your account as cash at the specified time.
Then comes the question of what to do with it – spend, save, or store. If you’re the type of person who wants wealth creation, and wants little to no hassles, then a DRIP strategy could make sense for you, because a DRIP automatically reinvests all the cash that comes in, back into the stock or ETF that paid it out in the first place.
Yes, you read that right. You don’t need to do a thing – if you set up a DRIP, then the cash that comes in through distributions or dividends is immediately reinvested in the same stock or ETF, so that your investment can continue to work for you, but now, with a little more money invested.
Compounding – A Portfolio Superpower
There is a quote that is often attributed to Albert Einstein, that says something like, “Compound interest is the eighth wonder of the world. If you understand it, you earn it. If you don’t, you pay it.”
I am not entirely sure he said it in that way, but there is truth to it. Compounding, or compound interest, is what happens when your money starts making money. We talked a little bit about this when we reviewed “The Richest Man in Babylon.”
Here’s a practical example. Say you start with an investment of $100,000. This investment earns 4% a year for 20 years. If you don’t do anything with this money and don’t compound it, then over 20 years, you have earned $4000 a year, or $80,000, meaning at the end of 29 years, you have $180,000. Not bad.
Now let’s see what happens if you let this compound. According to the using an online compounding calculator, if you start with $100,000 and do absolutely nothing but just reinvest the $4,000 a year, at the end of 20 years, you end up with $338,224.63, or a total interest earned of $158,224.63.
My colleague calculated what would happen if you used a DRIP strategy in your ETFs. Explaining that by reinvesting their distributions, investors can earn additional units, which can then generate more distributions.
That’s the power of compounding.
Things to Consider When Deciding on a DRIP Strategy
It may sound like I’m suggesting everyone use a DRIP, but that is not necessarily the case. There are some cases in which it might be a good idea, and others where it might not. Here are a few things to consider:
- Why are you investing? If you’re a younger investor, or are in a wealth-builder phase, then a DRIP strategy could make sense, as you can use the power of compounding to build up your nest egg. If, however, you need the income from dividends or distributions for your expenses, you might need the money upfront, so reinvesting it might not make sense. It depends on your own personal situation.
- What do you own? Investors should always remember that dividends and distributions are not guaranteed. Companies might be impacted by a down cycle and cut dividends, or a fund might not be able to make its distributions. In that case, acquiring more of the same asset might not always be the best step. Also remember that a DRIP reinvests in the same stock or fund. So if you worry about concentration, then you should keep an eye on the drip.
- Where are you buying? If you have room in a tax advantaged account like a TFSA or an RRSP, then you might get a tax advantage by growing those accounts. If you need flexibility in which accounts you utilize, then an automatic DRIP might not work as well.
- Who are you? Readers of this column know that for me, I focus a lot more on the ‘personal’ part of personal finance than then ‘finance’ part. It is important that you know who you are, because this will bleed into your financial life as well. If you are a person who needs automation and simplicity, then a DRIP might make sense for you. If you need to control every aspect of your life, including when and how you invest, then an automated strategy could stress you out.
What Should You Do?
If you’re curious about DRIP investing and want to see if it’s right for you by trying it out, it could be a good idea to pick a single stock or ETF and set up a DRIP for it. Once you do that, forget about it. Check it maybe once or twice a year, and don’t overthink the process. See what happens, and how you feel as time passes.
If it works for you, then you have a strategy to try for the rest of your portfolio!
As always, for investors seeking income, Harvest Portfolios has a wide range of covered call ETFs for investors of all stripes. Harvest income ETFs paid out $2.5 Billion in total cash distributions since launching the first Harvest ETFs in 2016. We have equity portfolios that focus on established businesses, leading themes, and secular trends across sectors, combined with an active covered call strategy to provide a dual approach of generating high monthly income and long-term capital growth. You can find out more about covered calls here.
Disclaimer
For Information Purposes Only. All comments, opinions and views expressed are of a general nature and should not be considered as advice and/or a recommendation to purchase or sell the mentioned securities or used to engage in personal investment strategies.
Tax, investment and all other decisions should be made with guidance from a qualified professional.
Commissions, management fees and expenses all may be associated with investing in Harvest Exchange Traded Funds (managed by Harvest Portfolios Group Inc. (the “Funds”). The funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the relevant prospectus before investing.
