A DRIP in the Bucket

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 […]



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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.

17 comments on “A DRIP in the Bucket

  1. Good article but one comment. At the end you comment that no one can predict which ETF strategy will outperform going forward but suggest investment choices should be made more on which of these strategies is used rather than if a DRIP is offered. Maybe it's just me but I found this confusing. If there is no reliable way to measure which ETF investment strategy is used (by the experts included Im assuming) that what, if anything does the average DIY investor use to decide which they have more confidence in? Again, it may just be me but it seems your last comment takes the reader in a circle.

    Can you clarify?


  2. People need to dig beneath the hype with ETFs – the lack of DRIPS and the trading fees (initial and rebalancing) make them hard to justify in comparison to something like TD e Funds. And the new Claymore etc DRIP offering, while a step in right direction, is not the answer – why? No partial DRIPs!! Which means it's half a solution.
    Based on my math (which could be wrong – please chime in with your pov) one would need a very large (millions) portfolio for the very small difference in MER between ETFs and TD eFunds to make a difference!!! Stop buying the ETF hype people!


  3. @Marie: There are not many certainties in investing: all any of us can do is put the probabilities in our favour. No one can say whether this ETF will outperform that ETF over the next ten years. We can't even say with certainty that stocks will outperform bonds. All we can do is keep costs low and control risk the best we can.

    @Robert: It’s important to look at the whole picture. You’re comparing ETFs to the cheapest index funds in Canada (the TD e-Series) funds, and you’re right that the fee difference can be very small. But you don’t need to have millions for the difference to become significant. See this post for the math details: http://canadiancouchpotato.com/2010/06/25/should-

    The other issue is that not everyone has access to the TD funds, and they do not cover all of the major asset classes, such as emerging markets and REITs. There are also many ETFs that track better indexes: for example, Vanguard’s VTI is much broader than index funds that track the S&P 500. The fact that dividends are not automatically reinvested in VTI is not a significant drawback. This is the main argument I tried to make in the post: the main driver of an investment decision should never be whether or not the fund has a DRIP.


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