Why should I DRiP?

[Primm]

Explain to me in layman's terms why I should reinvest my dividends via a DRP. I currently have a (not huge) amount - about $2,000 but increasing monthly - invested in 71% Vanguard ASX ETF and 29% in Vanguard US ETF.

My thinking is, if I ask Vanguard to reinvest the dividends, there won't be the right amount to be able to buy me whole shares. So the remainder (by my understanding, correct me if I'm wrong) sits in a reinvestment fund waiting for a big enough amount that they can buy more ETF shares for me at the next dividend distribution.

I pay tax on the dividends whether they are reinvested or not. So why would I not ask them to pay them into my brokerage account so I can immediately buy more shares when I combine them all (and add it to the amount I'm saving) so my money can go to work immediately instead of waiting another 3 months? The only thing I save is the brokerage fee, is that right?

What am I missing here?

[deborah]

You are right. One thing you might consider that DRP is post dividend when the share price is usually lower.

[Primm]

Yes, but if there's not enough in the dividend to buy whole shares then that becomes a bit self-defeating doesn't it?

[Jack]

Edit: Excuse me; I didn't realize this thread was about Australian investing.

In my Sharebuilder brokerage account, dividends get reinvested immediately, which means I own partial shares (of ETFs and individual stocks). In my Vanguard IRA I use mutual funds instead, but dividends get immediately reinvested there too, so I own partial shares of those funds.

If the dividends didn't get reinvested until there was enough money to buy whole shares, I don't think it would "count" as a "DRiP."

[Primm]

That's what Vanguard call it.

https://static.vgcontent.info/crp/intl/auw/docs/etfs/dividendplans/ETF_DRP_Policy.pdf?20140915|091500

And this is what they say about fractions of share prices:

"5.5 Fractions
Where a fraction of an ETF unit results from the application of the formula in Rule 5.4, that fraction will be rounded down to the nearest whole number and the remaining Distribution not applied will be carried forward as a credit balance on the Participant's Plan Account. No interest will be payable on the credit balance."

[bigchrisb]

Correct, AU DRPs are based on whole shares only in my experience.

You have a valid point about the mathematical problem with DRPs and whole shares.  For example, with my recent RIO dividend, I got 6 new shares, and have about $50 sitting there doing nothing until the next dividend.

Despite this, I still use DRPs for two reasons:

1. Behaviour. I know myself well enough to know that out of sight is out of mind.  If I see the dollars come in as income, I then have to make a choice to reinvest.  If I don't ever see the dollars, I don't have to deal with temptation.  I'm increasingly of the view that avoiding behaviour is one of the tricks to good long term investing, and this helps.

2. DRP discounts.  Some companies offer a discount on their DRP shares (0-5%).  That's a bonus you wouldn't get if buying with the cash. An extra fraction of a percent on the DRP shares balances out any loss of earnings from money not reinvested pretty quickly.

[deborah]

I am fairly confident that we don't have fractions of a share in Australia. Certainly every DRP I have ever investigated didn't. However, as we used to only be able to buy shares in the 100's in trade (a marketable quantity), there has been some improvement over the years. The marketable quantity used to be another reason to buy DRP, because you could get a number of small quantities and gradually add to your shareholdings.

[Primm]

I didn't know about the discounts, bigchrisb. Do you know if they apply to ETFs as well? I don't have any single company shares yet.

[BaldingStoic]

I pay tax on the dividends whether they are reinvested or not. So why would I not ask them to pay them into my brokerage account so I can immediately buy more shares when I combine them all (and add it to the amount I'm saving) so my money can go to work immediately instead of waiting another 3 months? The only thing I save is the brokerage fee, is that right?

With only a couple grand invested your annual dividend would only be $60 (assuming a generous 3% dividend rate).  If this is paid out quarterly then you're talking $15 chucks.  With such a small amount of money it's simply not worth your time to but into your brokerage account. Reinvesting the dividend automatically allows you to forget about it. 

Fast forward a few years ahead when you have $200,000 invested, then the brokerage strategy can work well for you.  You can then intentionally reinvest the dividend into the fund that maintains your optimal asset allocation. 

[bigchrisb]

One negative I forgot to mention earlier is what it does to your tax position.  Each DRP purchase is a new tax parcel for capital gains tax.  A pain in the butt when you come to sell. 

My personal choice is to deal with that when the time comes, and take advantage of the forces savings habits the DRP achieves today.

[Aphalite]

Here's a page from Bogleheads on opportunity cost - their conclusion is that it's minimal, and manual reinvestment of dividends helps with the problem chrisb mentions above. It also let's you do dynamic rebalancing instead of incurring tax costs if you rebalance annually

Pros/Cons"
http://www.bogleheads.org/wiki/Reinvesting_dividends_in_a_taxable_account
Analysis of opportunity cost:
http://www.bogleheads.org/wiki/Delaying_reinvestment_of_dividends

[Primm]

With only a couple grand invested your annual dividend would only be $60 (assuming a generous 3% dividend rate).  If this is paid out quarterly then you're talking $15 chucks.  With such a small amount of money it's simply not worth your time to but into your brokerage account. Reinvesting the dividend automatically allows you to forget about it. 

Fast forward a few years ahead when you have $200,000 invested, then the brokerage strategy can work well for you.  You can then intentionally reinvest the dividend into the fund that maintains your optimal asset allocation.

See, that's my issue though. Reinvesting isn't possible at the moment without adding funds precisely for the reason you state, that my dividend will be less than one share in the ETF (currently ~$70 and ~$110 respectively). If I leave that money in the DRP with no interest, that's a lost opportunity cost. With my numbers it could be sitting there for over a year!

Thanks for all the info. Pleased to have confirmed that my initial gut feeling was right on this, and while my investments are small at least (with associated small dividend payments) I'm better off taking the distributions as cash, paying the tax and immediately reinvesting rather than waiting for the distributions to add up to enough to pay for whole shares.