Regular readers know I’m a big fan of DRIPs (dividend reinvestment plans) for many reasons (see any of the posts in my sidebar, but especially How To Invest Commission-Free). But recently I’ve be rethinking some of my DRIP strategy. In the past I’ve been 100% reinvested, but the recent economic environment has me getting more proactive and critical of full reinvestment as a strategy. Here’s why.
100% reinvestment works best in a strong earnings growth environment. We are not in that environment right now, not even in Canada. When companies grow their earnings and want to keep the same payout ratio, they will increase their dividends and will not need to issue more shares. Hence your growing dividends will eventually be able to buy more shares than they were previously. Indeed, ideally, even your rate of “purchasability” would grow.
In a negative growth environment, your reinvestments might not only not be able to keep their purchasing power, but past gains can also be wiped out. As a case in point just look at what happened to Enervest Diversified Investment Trust (EIT.UN) over the past year. You may have been able to buy more units with each distribution, but this rapidly declined as their unit price fell, they cut the distribution, and then bought back shares.
Simply put, 100% reinvestment means you’re not diversified. It means your investment’s value is at the whim of the company’s decision on not only their distribution or dividend amounts, but also the amount of shares outstanding. It means, effectively, that you assume a very bullish position on that company’s future growth.
It may be free; it may get you a discount on the stock, but 100% full reinvestment is not a fail-safe strategy for growth. It can put your investment on a risky foundation, too.
Recommendation For DRIP Cashflow Diversification
Consider periodically withdrawing some shares from the DRIP plan and depositing them into your broker, so that you can receive some of the dividends in cash. While these dividends will not be automatically reinvested and you will have to actively manage them, the advantage here is that you can now redeploy the dividends according to what the current economic environment dictates.
(1) If it becomes obvious that deflation is hitting hard, you can use these to pay off debt and solidify your returns.
(2) If inflation is hitting really bad, you can use this cash to buy good yield and invest in interest-bearing vehicles.
(3) And you can always use it to reinvest back into a chosen DRIP — again, depending on which company has the best growth prospects at the time.
The overall point is that you need to remain flexible with your investment strategy in changing economic environments. As part of overall portfolio rebalancing, pay attention to your cash flows, not just total market values. Different economic periods require and suggest different cashflow strategies. If you were to simply remain fully reinvested and let your portfolio sit on automatic, then yes, theoretically your 20-yr returns might be boosted through greater leverage, but the stock’s performance could also wipe out significant value that might otherwise have been more usefully redirected to removing debt and building the low-risk savings side of your portfolio.Related Posts
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