Recently, I’ve received many phone calls and e-mails asking questions such as: Which is the best Canadian DRIP to start? How does one set up a diversified portfolio? How many DRIPs should be included? DRIPs are known to be inexpensive but why are they so expensive to start?
Let me start by saying that what follows are opinions not recommendations. I firmly believe that, when it comes to DRIPs, one size does not fit all. Individual experience, age, personality and tolerance to risk will lead to different perceptions and choices. What is good for one person’s situation might not be good for another’s. People must do their own due diligence and make their own choices.
That said, when asked by a newcomer what DRIP to start with I suggest two:
Bank of Montreal
The reasons are several. There are only a limited number of Canadian DRIPs. Believing these companies have longevity allows the small investor to accumulate shares quickly through the stock purchase plans (SPP). Both companies allow monthly optional purchases. Both companies allow for the sale of all or a portion of shares through the plan on a monthly basis. Both plans have no lower limit on the size of optional purchases. I have often wanted to send a cheque for $0.01 to these companies just to see if it would be processed. (OK! OK! Some websites and publications show a lower limit of one dollar for these companies but the prospectuses I have indicates none).
It is important to note that, other than for my perception of longevity, my reasons for choosing BCE and BMO has little to do with the qualities of the companies and everything to do with the qualities of their DRIP plans. The quality of the DRIP plan should be down the list of reasons for choosing a company as an investment. However, the friendly nature of these plans allows a new investor an easy way to learn the ropes with, perhaps, less risky companies.
I have just finished helping three separate groups make DRIP purchases. Many had questions regarding which companies, how many companies and how to keep costs down. Let’s deal with the costs first.
One recent e-mail concerned the shock a reader had when they found out that after paying discount brokerage fees of around $325 it would cost an extra $535 (including GST) just to take the shares out of street name so it would be possible to register in the various DRIPs. Total cost is around $860. Ouch!
Personally, going through a broker is my last choice in starting a DRIP. I’m in the process of helping a coffee group set up portfolios. One participant in the coffee group is in the process of establishing a ten DRIP portfolio. An estimate of her total commission to do this is around $40, some stamps and a few coffees. She took part in group purchases, splitting commissions with several others, to get her first two companies. Having the first two companies allowed her to offer to exchange the single share certificates with other DRIPpers to get two other DRIP companies. Two companies were transferred to her as favours from other DRIPpers. Once those DRIPs are established she will offer those singles for exchange to get the other four companies she is after.
One of the dangers of exchanging or transferring shares, especially with people over the Internet, is the reliance on trust that both persons will carry through on their commitments. To protect herself, the person above dealt with locally organized groups so exchanges could be done face to face. Over the Internet she exchanged with persons known to have previously completed transactions. A lot of trust is required in transfers and exchanges. These methods drastically reduce set up costs but it is important to guard yourselves accordingly.
In working with the groups above there were concerns about diversification, how and which companies to choose in setting up a DRIP portfolio. Let’s look at diversification first.
As Tom Connolly pointed out, a basic dividend producing portfolio would include a telecom, a pipeline, an electrical utility, a bank and Terasen, formerly BC Gas (http://dividendgrowth.ca/pages/old_site/yourself.html). As DRIPpers this gives us the following choices for a basic five company diversified portfolio by selecting one company from each sector:
Telecom: BCE, Aliant and Telus
Pipeline: TransCanada and Enbridge
Electric Utility: Fortis, Emera and TransAlta
Bank: BMO, BNS, CIBC and National Bank
In his January 2005 article, DRIPs - Your Non-RRSP, David Stanley showed just how important it can be to choose companies with a five year history of growing dividends. If we take the five sectors above and include only companies with a five year history of raising dividends the potential choices become:
Electric Utility: Fortis and Emera
Bank: BMO, BNS, CIBC and National Bank
If strict criteria of a five year dividend growth rate is maintained then the best diversification possible is only 4 sectors as no DRIP offering telecom qualifies. However, BCE and Telus have both raised their dividend recently. As well, in the pipeline sector, TransCanada Corp has raised their dividend three times since cutting it a number of years ago. Also worth considering, TransAlta, which already gives a 5% discount on reinvested dividends, has, over the past several quarters been issuing plan purchased shares from treasury with a 5% discount as well. That is an instant 5% return in a low growth situation.
Interestingly, based on the five year dividend growth rate criteria for selection Imperial Oil creates a sixth sector for inclusion. Considering the high price of oil and current interest in this depleting resource Suncor is also a possibility. Further, in discussing the idea of a basic 5 DRIP portfolio several people felt a trust should be included. So our basic Canadian diversified portfolio would be seven sectors:
Why am I calling it “Resource” instead of Oil? In the process of working with one group a sub-group of ten people decided to purchase Alcan reasoning it was a “buying opportunity”. Perhaps opportunity is an eighth sector.
How many DRIPs should a person have for risk’s sake? Many articles can be found on the Internet pointing to research showing there is no significant reduction in risk after choosing 8 to 12 good companies in the USA and 16 to 20 good companies in Canada. How many Canadian DRIPs should you have? The following is very much an opinion:
Diversification across sectors and by numbers of companies is a conservative approach to deal with investment risk. Using a company’s stock purchase plan consistently is conservative thanks to income averaging. To my mind, and I stress it’s only an opinion, if you do both it results in compounding conservatism. It is only an opinion, but I suspect the argument for including less than 16 companies in a DRIP portfolio is defendable.
What the various groups I’ve worked with recently seem to like is doubling the basic 5 DRIP portfolio placing two companies in each sector. This allows them to pick opportunities within a sector when one company is out of favour while risking no more than 10% of their total investment should any one company disappear. However, there is nothing to say this is the correct way to go.
Which companies? How many? There are many approaches and considerations when attempting to answer these questions. I hope the above will help guide you in some issues related to setting up an effective DRIP portfolio. Ultimately, it is what you, the reader, bring to the table that will determine the best DRIP portfolio for your situation.
Disclosure: I own all of the companies mentioned above except Aliant, Fortis, Emera, National Bank, Imperial Oil and Alcan.
At the beginning of 2005 Bank of Montreal began to withhold signature guarantee services for known clients wishing to transfer share certificates for establishing DRIPs. If you did manage to get certificates guaranteed at BMO during the period you know the employees at your bank don’t read memos. However, thanks to readers of this column who wrote to management over the serious consequences this action had for DRIPpers I have been informed by BMO’s head office that the privilege will be returned near the end of April 2005. This is a victory for the small investor.
From the BC Securities Commission:
Further review of the new legislation, for purposes of proposed National Instrument 45-106, indicates an exemption for direct stock purchases is contemplated and will be available once our new legislation has been proclaimed by the government.
If Alberta and Quebec follow suit Canadian corporations might soon start offering direct stock purchase plans. While a positive for DRIPpers the downside is the possibility of the introduction of fees to run these plans.
Robert Gibb, 401-2910 Cook Street, Victoria, BC, V8T 3S7 (250) 383-7075 firstname.lastname@example.org. Robert Gibb is a retired school teacher. He gives seminars on dividend reinvestment plans. Mr. Gibb is a frequent contributor to Internet DRIP boards under the nickname OperaBob.