By Leon De Wet

Some investors like to participate in Dividend Reinvestment Plans (DRPs). It’s a concept that has been popular for a number of years. So how do these plans work?

• Let’s say you own 500 shares in a company that announces a dividend of 10 cents per share.
• You have a DRP in place, so instead of receiving $50 in the form of a cash dividend (500 x $0.10), you receive 5 shares valued at$10 each, which increases your total holding to 505 shares.

There are three main positives for these plans.

1. They’re a cost-effective way to increase your shareholding. This is especially true for smaller portfolios because the extra shares are issued with no brokerage costs.
2. The company may issue the shares at a small discount to the market price.
3. It’s a way to encourage forced saving.

So, what are the potential negatives with these Dividend Reinvestment Plans?

Admin is one. Each dividend reinvestment is a separate share purchase, so administration can be a bit more complicated. You need good record keeping to ensure the capital gain or loss on each parcel is correctly calculated when the shares are sold.

Investors should also understand that some companies offer DRPs mainly to preserve cash, and so shareholders that fail to participate in a DRP will effectively have their ownership interest diluted as the company is unlikely to offset the dilution from the new shares issued by buying back shares on-market.

The last thing you should be aware of is that DRPS are not a tax minimisation strategy. The dividend is assessable income regardless of whether it is received as cash or shares.

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