If you’re interested in DRIP investing, Fidelity has a range of eligible funds. Check with your advisor to see what might be a good fit for you and your goals.
How to make dividends and compound growth work for you
For an investor, every dividend you earn may be an opportunity to improve your financial future, whether it comes from a stock, an exchange-traded fund (ETF) or a mutual fund. Once you receive a dividend payment, you can choose to spend the money, save it or put it right back to work inside your portfolio. The latter option may be a smart strategy to build wealth over time.
One tool that makes this easy is a dividend reinvestment plan, also known as a DRIP. If you’re thinking about using a DRIP, here’s what you need to know.
What is a dividend reinvestment plan (DRIP)?
Dividends are small, regular payments that some companies and funds send to their investors. Typically, they’re a share of the company’s or fund’s earnings. A DRIP takes those payments and uses them to buy additional shares automatically. This kind of quiet consistency can take emotion out of the equation and allow compounding to work its magic. It’s a popular strategy due to its potential for portfolio growth without requiring much effort on your part or ongoing decision-making with every payout.
What are the different types of DRIPs?
There are two main types of DRIPs: treasury DRIPs and synthetic DRIPs. Which one you can access depends on where your investments are held.
Treasury DRIPs
Some companies offer their own dividend reinvestment programs directly. Instead of paying you in cash, the company reinvests your dividends into new shares purchased directly from the company’s treasury stock. For instance, the company might pay the dividend using shares it holds internally, such as those acquired from a previous share repurchase program, instead of buying them on the open market.
Synthetic DRIPs
Many investors choose synthetic DRIPs, because they make reinvesting dividends simple. Instead of receiving the payment in cash, your brokerage automatically uses it to buy more shares at the current market price. This process runs in the background, doing all the heavy lifting for you.
When you’re enrolling in a DRIP, you can choose either partial or full enrollment. Partial enrollment means only a portion of your dividends are reinvested, and the rest is paid out to you in cash, whereas full enrollment means your entire dividend amount is reinvested.
What are the benefits of dividend reinvestment?
With a DRIP, your dividends go back into more shares of the company or fund, without any effort on your part. That means fewer decisions, fewer distractions and more time in the market – all of which can help you achieve your financial goals faster the longer you stay invested. A DRIP also removes the temptation to try to time the market or to spend the cash on impulse purchases, two decisions that can undermine long-term growth.
Understanding the role of DRIPs in investment growth
Investment growth doesn’t always come from big moves. Sometimes, it’s the small, steady steps that make the biggest difference. That’s the idea behind compound growth: over time, as you keep reinvesting your earnings, those reinvestments start generating returns of their own. This creates an opportunity for enhanced investment growth over the long term, helping you work toward your financial goals.
What are the tax implications of reinvested dividends?
Although reinvested dividends might not land in your bank account, there are still potential tax implications. The Canada Revenue Agency (CRA) considers dividends as income, for tax purposes, in the year they’re paid, even if they’re automatically used to buy more shares through a DRIP. The exception is if you’re holding these investments in a registered account, such as a Tax-Free Savings Account (TFSA), a Registered Retirement Savings Plan (RRSP) or a First Home Savings Account (FHSA). In these cases, your reinvestments will grow either tax-free or tax-deferred, depending on the type of registered account.
If the dividend-earning investments are held in a non-registered account, you’ll need to report the value of the reinvested dividend income when you file your tax return.
There’s no flat tax rate for dividends. It depends on the type of dividend and your marginal tax rate, which is based on the amount of income you earn. Reinvested dividends can be easy to overlook on your tax bill, because you’re not receiving the money directly, but it’s important to report them accurately. Good news – these will typically be included on the T3 or T5 slip from your financial institution for non-registered accounts. If you’re looking to estimate your potential dividend tax bill, you can use our tax calculator.
Key takeaways
Some of the greatest long-term investing gains have come from simple strategies that are consistently applied. A DRIP can turn regular dividend payments into a steady mechanism for future growth, with the potential to boost your portfolio with every reinvestment. It removes the temptation to react to short-term market noise and gives you one less decision to make along the way. If you’re looking to learn more about how you can add DRIPs to your investment strategy, a financial advisor can help you navigate the process and design a plan to help move you closer to your goals.
