A DRIP in the Bucket

A DRIP in the Bucket

MARCH 10, 2011

One of the downsides of using ETFs—as opposed to index mutual funds—is that dividends and interest are not automatically reinvested. Instead, they are paid in cash, where they often sit idly in your brokerage account for months. This happens even more frequently now that many ETFs have started paying distributions monthly, rather than quarterly as in the past.

To address this issue, both Claymore and BMO offer dividend reinvestment plans (DRIPs) for their ETFs. For those who are unfamiliar with DRIPs, they allow investors to receive distributions—whether dividends from stocks, interest from bonds, or return of capital—in new shares rather than in cash. Only whole shares are possible: so if the ETF is trading at $20 and you’re eligible for $67 in dividends, you’ll receive three new shares plus $7 in cash.

If the amount of email I am receiving is any indication, these programs are extremely appealing to investors. Indeed, I have heard from people who are specifically choosing ETFs from Claymore and BMO rather than those from iShares because of the DRIP feature. (iShares does not currently offer such a program.) I believe this is an error in judgment.

While the automatic reinvestment of dividends is convenient, it should not be a major factor in determining which ETFs you use to build your portfolio. Here’s why:

Synthetic is Just as Real

ETF investors may not realize that discount brokerages offer “synthetic” dividend reinvestment plans. Unlike traditional DRIPs, which originate with the company issuing the stock or ETF, a synthetic DRIP is handled on the brokerage side. The ETF pays its distribution in cash, and the brokerage then purchases new shares in your account, without charging a commission.

There is no meaningful difference between the DRIPs offered by Claymore and BMO and the synthetic plans offered by brokerages.

Every brokerage handles things a little differently, and not every ETF is eligible, but most of the major firms support synthetic DRIPs for iShares ETFs. When I put the word out, investors confirmed that is the case at TD Waterhouse, CIBC Investor’s Edge, RBC Direct Investing, Scotia McLeod and iTrade. If you use another brokerage and can confirm whether they offer this service for iShares ETFs (and if so, for which specific funds), please share with your fellow Couch Potatoes by leaving a comment at the bottom of this post.

Unfortunately, fewer Canadian brokerages seem willing to reinvest dividends from US-listed ETFs. If yours does, again, please share below.

Don’t Let DRIPs Be the Driver

The most important factor in your decision should be the investment strategy that the fund uses. Even if your brokerage does not allow you to DRIP a specific ETF you’re considering, it shouldn’t influence your decision.

The fact is, over the long run, whether you use DRIPs or simply collect your distributions in cash and reinvest them a couple of times a year (any time you add new money or rebalance) is not likely to have any significant effect on your returns.

The same can’t be said about ETFs that use different strategies. Most iShares equity ETFs are traditional cap-weighted index funds, while Claymore’s flagship products use a fundamental indexing strategy. BMO, meanwhile, has introduced a number of ETFs that use an equal-weighted strategy. Over time these differences are likely to have a much greater effect than the immediate reinvestment of dividends.

All of these ETFs may be good choices, and no one knows which of these strategies will outperform going forward. But the point is that you should select your investments based on your confidence in the strategy, not on the availability of a DRIP.

{ 22 comments… read them below or add one }

Mike Holman March 10, 2011 at 8:54 am

Good info. I’ve known about the synthetic drip available at brokerages for a while, but I imagine that lots of people don’t.

Questrade offers a synthetic drip. I’m positive it includes the Canadian iShares ETFs – I remember asking them a while back. I’m not sure if they offer it for US-listed ETFs or not.

Marianne March 10, 2011 at 9:23 am

Thanks Mike. I do use TD’s drip on all my investment accounts – works well. I always wondered if when I drip non-RRSP/TFSA accounts, are the dividends considered taxable even though re-invested in shares? I don’t think this would be the case with automatic drips. Do you know how this is handled?

Canadian Couch Potato March 10, 2011 at 9:32 am

@Marianne: If you use a DRIP in a taxable account you are still responsible for paying the taxes, even if the distributions are received in shares rather than in cash.

Brandon March 10, 2011 at 9:34 am

I was researching synthetic DRIPs just yesterday, and I read on the Financial Webring Forum that you can DRIP some of the Vanguard ETFs with TDWH. This would be helpful in order to avoid forced currency conversions.

Here is the link to the thread – bottom of page 10: http://goo.gl/ZZz6g

Pascal March 10, 2011 at 10:22 am

I have synthetic DRIPs setup for VTI, VEA and VWO for the last 12 months at TDWH. They worked well at distribution time in December. It appears that TDWH converts the cash distributions at US-CAD foreign discount rate, then buy the corresponding number of Vanguard ETF shares.

Cheers

Flagen March 10, 2011 at 11:59 am

@ Pascal and CCP – I have the same three Vanguard etfs dripping at TDWH and they confirmed for me that they drip whole shares in $US before making any conversion and any remainder is paid out in Canadian using the current exchange rate. It’s not ideal for avoiding foreign exchange fees, but not too bad.

Canadian Couch Potato March 10, 2011 at 12:26 pm

Great to know that TD Waterhouse will do this with Vanguard ETFs. I know that Scotia iTrade does not. Curious about other popular brokerages. Has anyone successfully DRIPped US-listed ETFs from providers other than Vanguard?

The Dividend Ninja March 10, 2011 at 2:17 pm

Hi Dan,

TD Waterhouse will not DRIP Claymore as of my last enquiry

Canadian Couch Potato March 10, 2011 at 2:47 pm

@Ninja: That’s odd, because Claymore’s site indicates that virtually all brokerages support their DRIP. I’d suggest you email Claymore and ask if there’s something specific you need to do.

Paul March 10, 2011 at 4:11 pm

I see DRIPs as tiebreakers…. but there are a lot of ties among various ETFs which are awfully similar, or strategies I’m not equipped to seriously compare (XRE vs ZRE for example). For that reason, for bonds I see Claymore’s as being more interesting simply for the DRIP.

What I like most about DRIPs is that they mean I can “forget” my investments…. if I don’t look at them for 3 years, there shouldn’t be as much of a loss from un-reinvested dividends as without DRIPs.

I’m with BMOInvestorline, who have no DRIPs other than a list of 60 stocks, plus their and Claymore ETFs.

Open source portfolio March 10, 2011 at 4:16 pm

I think drips are a great idea for the passive investor. However, I like to fine tune my investments and accumulate the dividends in cash. Once I see a good deal I’ll use that cash reserve to invest.

Andrew Hallam March 10, 2011 at 8:15 pm

Nice article Dan,

I guess I was under the impression that if a brokerage (like Investor’s Edge, for example) reinvested dividends for investors, then it didn’t matter what ETF or stock it was. It sounds like I was wrong. When I lived in Canada, I thought they’d reinvest dividends from anything with a dividend pulse. They did it with every stock and ETF I owned. So what’s the deal? Will they or won’t they reinvest dividends for anything with a dividend pulse? From what you (and other readers are suggesting) it’s selective. And I must just have been very fortunate with the holdings I had.

Canadian Couch Potato March 10, 2011 at 8:39 pm

@Andrew: It’s definitely selective at most brokerages. I have no idea how they make their choices, though. It seems pretty random.

S.J. March 10, 2011 at 9:14 pm

@The Dividend Ninja & CCP: I DRIP Claymore’s CBO inside my TD Waterhouse SDRSP account, so I’m certain it’s possible. Now… whether it’s Claymore’s DRIP or TDW’s ‘Synthetic’ DRIP, I’m really not sure. But, it’s there every month.

Cheers.

David Jones March 11, 2011 at 12:28 am

My accounts are at RBC Direct. They drip only some ETFs. I hold both i-Shares and Claymore and I have asked several times why they only drip some of my ETFs and not others. I have never been able to get an answer. As suggested, it appears totally random what they will drip.

gibor March 11, 2011 at 12:38 am

TD Waterhouse for sure doing DRIP for Claymore’s CBO

MoneySheep March 11, 2011 at 8:39 am

For DRIP of stocks (or ETFs), I believe the underlying companies actually issue new stocks to the shareholders. This has a dilusive effect. (This is contrasted with companies buying back shares, the earnings/dividends in the next round are divided into smaller number of shares). So DRIP is not good for shareholders overall.

Canadian Couch Potato March 11, 2011 at 8:53 am

@MoneySheep: That isn’t true. Individual companies may issue additional shares and pay these as “stock dividends,” which do dilute equity. But the situation is not the same with an ETF.

ETFs are open-ended, like most traditional mutual funds. This means that when they receive new inflows of money (and that includes cash dividends that are returned to them), they purchase additional assets. They don’t just slice the pie into thinner pieces.

Michael Davie March 11, 2011 at 12:13 pm

Qtrade (not to be confused with Questrade) drips at least some iShares ETFs; I have one set up with them for XBB.

My Own Advisor March 11, 2011 at 5:28 pm

Nice post Dan.

Right or wrong, I pretty much DRIP everything I own, unregistered stocks, stocks in TFSA, stocks in RRSP and ETFs in RRSP. I want to take advantage of those investments buying more investments as much as possible.

DRIPs are never the sole driver for an investment selection, but it’s certainly a nice perk

Have a good weekend!

Mark

Chris March 11, 2011 at 5:37 pm

I have a DRIP going on XBB, XIU, XSP and XIN with Qtrade.

I too use DRIP wherever I can, and have never had a problem. Individual stocks and ETFs (although I’ve never done a US ETF).

Canadian Couch Potato March 11, 2011 at 9:53 pm

@Mark: I agree that DRIPs are a nice perk — I use them myself, too.

Thanks to everyone who everyone who shared their experience with various brokerages. Hope other readers found this useful.