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Drip Drip Drip

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Dividend Reinvestment Plans


At the risk of sounding like a weird, cat household, my wife, Michelle, has a tender spot for strays. Not only did she shelter Catherine, but she’s fostered a pesky habit of feeding any and all ferals who stumble in our yard.  Now that the word is out, we may see 3 or 4 different ones a day; our pantry has become Petco.  Michelle has developed an exceptional affinity for a distinctive, calico kitten.  She even shared the tidbit that 1 in 3000 calicos is male[i].  I’m guessing this one is female.  Our blog has hit rock bottom.


Unfortunately, this particular calico has become affectionate towards her.  This is exactly how Catherine weaseled her way indoors.  Oh, I forgot to mention: we spent a fist full[ii] on her in January - to have leftover gauze removed from a poorly executed spaying.  Still yet to see any semblance of ROI on Catherine, Michelle wants to double down with another feral.  All this nonsense has me wondering if it’s logical to question automatic reinvestment plans.  I’m actually questioning a lot of things.


Intentional or not, most of us utilize Dividend Reinvestment Plans through our 401k’s, IRA’s or general investments.  It automatically buys additional shares anytime there is an income or capital gains payment, usually transaction cost free.  DRIPS are simple, cost effective and avoid the emotional timing issue of when to buy.  Numerous studies have calculated the long term, monetary benefits of automatically reinvesting dividends vs. taking them as cash. The graph below shows an average growth & income fund yielded 300% more over 40 years when dividends and capital gains were reinvested vs. leaving as cash.

In theory, reinvesting sounds like a financial home run – and sometimes it is.   But what if your investment horizon isn’t indefinite?  Mutual fund companies love to market their 5, 10, 20 year and lifetime returns.  That’s great but real-life investors’ timelines aren’t so seamless.  As Nationwide Insurance Co. has cleverly coined: “Life comes at you fast”.  Peyton Manning makes me chuckle.


What about cost basis and taxes for reinvestment?  In retirement plans, disregard both.  But if outside of a tax shield, they play major consideration.  Every time a dividend or distribution is payed & reinvested, it adds to your cost basis.  If fund XYZ makes a $1000-year end distribution, that is added to your cost basis.  Why?  It’s taxable and you’ll be receiving a 1099-div form to reflect that.   Investors mistakenly think that even if they didn’t take the money out or sell, that a taxable event didn’t take place.  Hence, the beauty of retirement plans.


Cost basis record keeping can be a bit more cumbersome – especially for individual stocks.  Historical, fractional shares bought with dividends can be a headache come sell time.  I’ve done forensic cost basis accounting for AT&T shareholders including all the Baby Bell splits from 40+ years ago. And specific share lot identification?  It will drive you to drink (more).   Thankfully, our portfolio software captures basis info and brokerage firms were mandated in 2013 to report all basis.  But for you home gamers using old DTC companies, like Computershare - who custodian the actual stock certificates, finding accurate cost basis could prove challenging.  If you fail to provide any, the IRS may deem it zero and tax all proceeds.


What are some non-financial considerations?  Foremost, I would consider a person’s financial need.  Do they need the interest and dividends to supplement their budget or lifestyle?  What about age? I would broadly suggest anyone under 60 continue to reinvest.  But if you’re nearing retirement or taking Required Minimum Distributions (RMD’s) to consider taking some cash.  And asset allocation should be weighed also: terrific performing stocks and mutual funds start to overwhelm the rest of the portfolio.  Great problem but should be addressed.


Lastly, the elephant in the room: market timing.  Where are we in a particular market cycle?  If we’re late, be defensive and slow reinvesting.  If early, be aggressive and reinvest.  Unfortunately, market cycle inflection points are not so transparent.  In fact, they’re un-knowable – despite what you may read or hear.  But here could be a subtle clue: mutual fund distribution size.  In the peak year of 2000, mutual funds paid out $512 billion in capital gains & dividends.  That fell to $130 billion the following year.  In 2007, they paid out a record $690 billion only to fall 70% during the 2008 financial crisis[iii].  The 2018 distribution totals aren’t finalized, but anecdotally, I can say they were extraordinarily high - some funds’ distributions climbing to 40% of net asset value.   Causation doesn’t necessarily equal correlation but….


On balance, DRIPS make a lot of sense for most investors.  Sure, there are wrinkles to consider.  But their ease and simplicity take the decision making and investment angst out of our hands. Most importantly, they have generated steady wealth and sneaky, good returns – much better than cats.

Fiscal Fitness is a publication of Houlihan Asset Management, LLC for the benefit of its clients and friends.     Houlihan Asset Management.  Wealth Counseling/Asset Management. Copyright 2019


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