If you got a raise recently, one of the best things you can do is to invest more of your money.
You have more disposable income now – what better way to use it than to invest in your future?
Maybe the one drawback of investing a greater percentage of your money than you would have in the past is that you might feel you have to spend more time on investing now.
You have more money in the markets, and therefore more to lose – shouldn’t you spend more time on investments then?
You could view things in line with the thinking above, but you don’t have to. By automating your investing, you can generate higher returns than you would by actively trading.
If you’re investing in dividend stocks, doing this is especially simple. Many stocks come with built-in plans that let you reinvest your dividends automatically. This has the effect of increasing your dividend income over time. In the subsequent paragraphs, I’ll explore how that works.
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DRIP plans
Dividend reinvestment plans (DRIPs) are programs that allow you to re-invest dividends you earn, increasing your share holdings without incurring trading costs. The way they work is that they automatically reinvest your dividends back into the stock that paid them. By doing this, you increase your number of shares, as well as your dividend income (barring unusual circumstances such as dividend cuts).
There are two types of DRIP plans you can implement:
- Those offered by the company whose stock you own. These usually come with a price discount (i.e., you buy the stock a little below market), and no trading fees.
- Those offered by brokers. These plans usually have lower trading fees than other trades your broker offers you, but no discount.
Having explored what a DRIP plan is, we can now look into setting one up.
How to set up a DRIP plan
There are two basic ways to set up a DRIP plan. The first is to contact the investor relations department of the company issuing the stock. If they have a DRIP program, they’ll let you know how to initiate it. The second is to contact your broker by phone. After you call them, they’ll ask you which stock you want to reinvest in. Then, they’ll set up the DRIP for you.
A real-world example
A good example of a stock with a DRIP program is Fortis Inc (TSX: FTS). Fortis is a Canadian utility stock with a 3.2% dividend yield. It has raised its dividend every year for 52 consecutive years. The company offers a DRIP program that gives investors a 2% discount on the stock price.
Fortis’ DRIP program increases investor returns and dividends in three ways:
- It gives a lower purchase price than can be obtained on the open market.
- It increases dividend income by adding more shares.
- It increases the effect of future dividend increases, which appear likely given Fortis’ historical trajectory and ongoing commitment to sustainable growth and a modest payout ratio.
For the three reasons above, I think an investor in Fortis stock who sets up the DRIP program is likely to increase their returns over time.
