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DRIPping South Into the U.S.

by Robert Gibb

With two DRIPs you become a mutual fund manager able to favour one stock over another and control fees.

The U.S. has over 1200 dividend reinvestment and optional cash plan companies. Based on population and market capitalization, Canada should have about 120 such companies. The number is nearer 30, which are largely banks and utilities. Diversification is a problem for a DRIPper limited to Canadian companies. I began to DRIP across the border three years ago in an ever-evolving learning process. Here are a few tricks I’ve learned that might lead to better management of your chosen U.S. companies.

Banking

This is the most important part of this article. Get this right and it will save money and frustration.

The U.S. Securities and Exchange Commission requires that purchases of U.S. stocks and bonds by foreigners must be made through either a U.S. bank or a branch of a foreign bank that is physically located within the U.S. The latter is convenient for most Canadians.

There are two types of U.S. Dollar accounts at Canadian banks. The majority of Canadians simply open a U.S. Dollar account at their local bank branch. This will not work with a U.S. DRIP. If you open this type of account, any cheques you send will be rejected.

When using a Canadian bank for U.S. DRIP purposes you must open a U.S. Dollar account with cheques that are cashable at a branch of that bank in the United States. Be prepared for the teller to call head office to confirm this. The Toronto Dominion (TD) U.S. banking specialist I spoke to in Victoria, British Columbia had dealt with this request only three times in 20 years. This type of U.S. Dollar account will have U.S. transfer codes at the bottom of the cheque.

I use the Bank of Montreal in Victoria, British Columbia with cheques that are cashable in New York City. Royal Bank uses Security First Network Bank while TD uses Waterhouse Bank. The Canadian Imperial Bank of Commerce and Bank of Nova Scotia did not respond to my queries.

If you have an error in a U.S. DRIP account, check to see if the transfer agent failed to note the U.S. address on the cheque and rejected it. Highlighting the cheque and attaching a note to it are good ways to draw attention to the U.S. address.

The U.S. Advantage

Americans have more and cheaper ways to purchase DRIPs. U.S. DRIPping companies make purchases more often, sell shares for DRIP investors, provide safekeeping for share certificates and might give product discounts to shareholders. There are substantially more growth companies offering DRIPs in the U.S. It is easier to develop a diversified portfolio in the U.S.

Purchasing Shares

U.S. DRIPs can be acquired through a stockbroker. DRIPS are also acquired by Direct Stock Purchase (DSP). DSPs allow an investor to make an initial investment with the company without going through a third party such as a broker. If you use direct stock purchases, the company will then give an investor the option of registering in the company DRIP. At the moment there are no Canadian companies offering DSPs.

When using a third party, for convenience and cost, I favour the Temper of the Times service offered through MoneyPaper magazine (800-388-9993). For US$20, Temper of the Times purchases your initial share(s), then registers the investor in the company DRIP. Temper will purchase up to 100 shares of an individual company for you. Expect a 6 to 8 week process. Temper offers several Canadian DRIPs at a 40-60% savings over Canadian discount brokers. Temper requests a 10% cushion on a recently quoted price to cover any appreciation in share price to completion date. As some shares fluctuate quickly you might choose to send a larger cushion. Temper refunds the difference.

Some U.S. brokers offer "special deals", recently including a 100% rebate on commission and transfer fees for single share purchases to start DRIPs.

Bypassing brokers altogether, some 700 U.S. companies allow direct enrollment. As many DSPs have fees to start, favour this method only when it is cheaper than through Temper of the Times (or some other third party). Many DSPs have a high minimum investment requirement. It is usually possible to spread the payments out with a commitment on the investor’s part. For example, a $1000 or $500 minimum investment can be spread over 10 or 5 months in $100 installments.

Using a DSP it is possible to start some U.S. DRIPs with less than a whole share. Johnson Controls (JCI) recently traded at US$68. This was above JCI’s minimum $50 investment requirement. Conversely, some U.S. DRIPs require more than one share to start a plan. Make sure you know how many shares are required before you purchase. For example, Pepsi must be purchased through a third party and requires 5 shares to participate in the DRIP.

Transferring Shares

Would you like to transfer a single share of Coca-Cola to each of your grandchildren? Usually all you need is a stamp guaranteeing your signature from your local bank manager on the back of your optional cash payment (OCP—called Share Purchase Plans in Canada) form to process this request. Occasionally, you will receive a follow-up letter saying the form must be stamped by a participating member of the "Medallion Program". This program might be common in the U.S. but is apparently only available at Canadian bank and broker head offices in Toronto or Montreal. Writing a letter to the plan administrator indicating the difficulty of getting a further stamp and the reluctance of banks and brokers to provide this service for an unregistered plan might solve any problems.

Sources of DRIP Information

The two best sources of information on DRIPs are the library and the Internet. The Motley Fool has two boards devoted to DRIPs. These boards are a good starting point when seeking help and information. Broker discounts, like the one mentioned previously, are found and discussed here. There is no membership fee.

Charles Carlson provides a single sheet listing all U.S. DSPs, minimum investment requirements and transfer agent 1-800 numbers when you request a free sample of his newsletter (219-852-3220). His newsletter cost US$99/year.

Information on plans of individual companies and minimum investment requirements are found at NetStock Direct. Netstock offers easy DSP plan registration and Web site links to company home pages. This is a free service.

MoneyPaper provides information on companies of interest. The regular yearly membership (US$90) was reduced 50% for new subscribers recently. Membership is not a requirement but it reduces the share purchase fee from US$30 to US$20 and only US$15 for companies mentioned in each issue.

If you are overwhelmed by the sheer size of the U.S. DRIP world then George Fisher’s site is a must visit. Mr. Fisher (847-446-4406) uses an easily followed combination of technical and fundamental analysis to determine the historical top 10% of U.S. DRIPping companies. He then categorizes them by sectors and timeliness for diversification. George also takes the time to give comprehensive answers to queries on the Motley Fool boards. He has a regular column at NetStock Direct covering DRIPs.

Pseudodrips and Fees

The Canadian advantage is that our DRIPs are relatively fee free. Many U.S. DRIPs are fee free (KO, PEP etc.). However, many are fee heavy (CPQ, IBI etc.). It is not uncommon for U.S. DRIPs to charge $5 (or more) plus a per share fee for optional cash payments. Some U.S. DRIPs also charge a fee for dividend reinvestment. There are ways to reduce these fees.

Pseudodrips are Internet deep discount stockbrokers. BuyandHold offers unlimited, twice-a-day trading for US$9.99 per month or US$2.99 per individual trade. Sharebuilder charges US$2 per trade. Both reinvest dividends for free. Smart Americans use pseudodrips to reduce fees and to purchase companies like MicroSoft that do not offer a dividend reinvestment plan. Presently BuyandHold and Sharebuilder are closed to Canadians but they are aware of strong Canadian interest. Hopefully, a Canadian pseudodrip will appear soon.

One method to reduce fees is to send fewer but larger optional cash payments. Another method is to use automatic bank withdrawals (ABW). Many U.S. companies reduce OCP fees significantly with ABWs. Automatic bank withdrawals can sometimes be set up over the Internet by linking to a company’s investor page through NetStock Direct.

Record Keeping

U.S. corporations paying dividends to non-U.S. residents are required to withhold income tax. When you start a U.S. DRIP the transfer agent often sends a W-8 or W-8BEN and a W-9 form with the registration materials. These forms are very confusing. If you are a Canadian citizen living in Canada only complete the W-8 or W-8BEN. Dividends will be subject to 15% withholding tax instead of 30% by tax treaty. Report dividends earned and tax withheld from U.S. DRIPs on your Canadian tax returns.

Capital gains are payable in Canada. To simplify the calculation of Adjusted Cost Basis (ACB) you might send Optional Cash Payments (OCP) based on multiples of C$50.00. For example, $100.00 (2 x $50.00) Canadian might equal an OCP cheque for US$65.64. Convert dividends reinvested back to Canadian dollars using the most recent exchange rate. For example, suppose, after withholding tax, you had dividends of US$2.00 reinvested. If this occurs in the same month as the previous example, divide US$2.00 by 0.6564 to account for C$3.05. This will allow you to keep an accurate record of expenditures in Canadian dollars.

Income averaging through a year makes it difficult to determine how a DRIP portfolio is performing relative to any index that reports data over a year. Investing $1200 for a year in an index that gains 12% on a straight-line graph would gain $144. If one were to income average $100 in 12 installments into the same index over 12 equal time periods in the same year the gain would be $78. Yet this return would also match the return of the index.

Jennifer Krou of Austin, Texas provides a simple and elegant solution to this problem: Every time an OCP is made to a DRIP make an equal imaginary purchase of a Standard & Poor Depositary Receipt (SPY: AMEX). There are many sites on the Internet that would allow you to record this for free. For example, "What If I’d Invested" calculator at NetStock Direct, and a free DRIP recording spreadsheet that can be downloaded from George Smyth’s site. Many sites like Motley Fool and "home pages" allow you to keep track of your portfolio for free so you could record imaginary purchases there.

Doing this will allow you to compare the value of your purchases against an equal and imaginary performance of the S&P 500. If you wish to be even more accurate, count real dividends reinvested in your DRIP portfolio and SPY dividends as further imaginary purchases. This same method could be applied to a Canadian DRIP portfolio using an appropriate index.

Conclusion

There are many things for Canadians to consider when DRIPping south. People will find new and better ways to complete the process. Hopefully, this article will help you avoid some of the pitfalls and it will help you become better fund managers.

Robert Gibb, 106–1217 Pandora Avenue, Victoria, BC V8V 3R3 (250) 383-7075 [email protected] Robert Gibb is a retired school teacher. He gives free seminars on dividend reinvestment plans. Mr. Gibb is a frequent contributor to the Motley Fool DRIP boards under the nickname OperaBob.

© Canadian MoneySaver, PO Box 370, Bath, ON K0H 1G0 613-352-7448 - Published May 2001