Dividend Reinvestment Plan (DRP)

Recently I purchased the Keppel Reit while in search for good income stock. Admittedly Keppel Reit is not a fantastic Reit to own but I decided forge ahead to buy this stock mainly because of its DRP (Distribution Reinvestment Plan) feature. DRP, simply, is a dividend scheme that allows the investor to claim shares as dividends instead of cash. So what’s the deal about DRP?

Compounding Power + 0 Commission

I had always been a fan of compounding interest because of its power to grow wealth exponentially given the necessary time. Supposed you re-invest all of the dividend back into Keppel Reit, you can double the value within 10 years (at prevailing dividend yield of 7%, constant dividend and price). Receiving cash and not investing it, you will need 14 years to receive to get back the capital. I had tried to “reinvest” my dividends in Singpost before but I stopped doing it because of the commissions needed to buy and sell small lots – roughly around $10. So while many books advocate the need for dividend reinvestment, there is a limitation because of the commissions needed. Hence one of the attractive feature of DRP scheme is that it eliminates commissions from brokerages when you reinvest dividends.

Investing Discipline

Another advantage of DRP is forcing the investor to invest long term. This is one of the main intentions of companies when they offer DRP schemes and it is also my reason to invest with them. When u opt for DRP, the odd lots you receive periodically make it very hard to divest your holdings. It is a strange concept, but personally, by receiving these odd lots, I’d be forced to commit to the company. As a result, I get to reap the results of compounding returns through long term investing. As someone that gets tempted to sell whenever share price is up, this is a very good self-imposed discipline plan.

While I like the idea of DRP, there are many who will do not like DRP. Admittedly there are disadvantages to DRP and here are some of them

Selling is a Problem

While DRP commits you to a company, it also makes the selling process very hard when you decide to take the money elsewhere. Because of the odd lots, you either have to sacrifice the extra commission fee or just keep the odd lots. However, with the scaling down of trading size to 100, keeping odd lots is less costly.

Investing in a wrong company

A huge disadvantage of DRP is actually if you invest in the wrong company, and this is the biggest hurdle I had to clear before I decided to opt for DRP. Suppose I invested in 1000 shares of Keppel Reit for $1 per share. When it announces dividend of $0.017 per share, I get 17 shares at the price suppose the issued share is also at $1. If the share price tanks to $0.80 1 year later, I actually will have a 20% capital loss on that dividend compared to 0% if I opted for cash! This is the scariest part of DRP that you will have to consider before opting for it.

In this case however, I reasoned that I want to opt for DRP because I see the viability of the trust in the long term. Also, the regular dividends that Keppel Reit issue are very beneficial in terms of compounding power. So I feel that in the long term, the compounding effect will overweigh capital loss notwithstanding the fact that depressed share price will have chance to recover in the long term. In addition, when prices are depressed you get to receive more shares as dividend assuming dividends are CONSTANT.

Having said my piece, what are your thoughts to DRP? Will you subscribe to it given the option? Will you specially hunt for companies that have DRP? Leave your comments!