For as long as this blog has been in existence, we have promoted dividend reinvestment.
Firstly, what is dividend reinvestment?
Dividend reinvestment is when one sets one’s brokerage account to use dividends from a stock to purchase additional shares when the dividend is issued.
The feature is available at most brokers, custodians, and transfer agents.
Example
Let’s look at an example.Suppose you have purchased 100 shares of a stock. For simplicity’s sake, let’s say the stock price at the time when the next dividend is issued is $11.25. Also, let’s assume that the dividend is $0.3375 per share, which is a 3% yield.
Since you own 100 shares, the total dividend received is $33.75. You could have the $33.75 deposited in your account, or if you choose dividend Reinvestment, the $33.75 could automatically reinvest in the same stock.
If you chose dividend reinvestment, your $33.75 will purchase 3 shares. This means that you now own 103 shares.
When the next dividend is issued, it will be based on your 103 shares, which will be (assuming no dividend increase or cut) $34.7625
The dividend of $34.7625 is an increase of $1.0125 from the initial dividend.
The number of shares that the $34.7625 will buy depends on the price of the stock when the dividend is issued. For ease of this example, let’s say the stock increased to $11.50 per share. At $11.50 per share, the dividend of $34.7625 will buy 3.022826087 additional shares. This will bring your ownership up to (103 + 3.022826087) 106.022826087 shares. (Some rounding will likely be done.)
That is how dividend reinvestment automatically increases one’s share count. And since dividend reinvestment is like a “set and forget” setting, it remains in effect until you turn it off.
A potential downside of dividend reinvestment
As you noticed in the example, after the first dividend you own 103 shares. After the second dividend, you will own 106.022826087 shares.
That fractional share of .022826087 may or not be a problem. Can the broker handle fractional shares without friction? These days most brokers charge no commission to buy and sell shares. Does this apply also to fractional shares?
Experience
In my (admittedly limited) experience, brokers and custodians I use have had no trouble handling these fractional shares. However, I have seen issues arise when using transfer agents.
Some transfer agents do not have the option to round up. Suppose we follow the example above and have now 106.022826087 shares of a stock. With dividend reinvestment, we will increase our share count, however will never reach a full solid round number of shares. This may or may not be a problem when it comes time to sell or transfer the shares. Fees for selling through transfer agents can be excessive, even though selling through a broker is simple and usually commission free.
Proposal
So my proposal is for transfer agents to implement two additional features in their plans.
Firstly, allow purchasing of a fractional share so that the number of shares can be a whole number. For example, in the above example, where you own 106.022826087 shares, allow purchase of 0.977173913 share so that the share owner can have a round number of shares, namely 107 shares. This would be accompanied with turning off standard dividend reinvestment.
Secondly, and alternatively, implement a feature where dividend reinvestment only purchases whole shares. In the example above, when owning the 103 shares, the following dividend $34.7625 would purchase 3 whole additional shares at $11.50 per share for $34.50, with the remaining $0.2625 be cash deposited in the shareholder’s cash account (usually a checking account). Of course, if the amount of a dividend was less that the cost of a single whole share, no purchase would be made and entire dividend then goes to the shareholder’s cash account.
These two new features would greatly increase the flexibility of transfer agent’s investment plans on behalf or shareowners.
What do you think of these plans? Let me know here.
Illustrated is a color lithograph of Yosemite’s thermal springs, from 1883., from “Annual report. United States Geological and Geographical Survey of the Territories.” Courtesy Biodiversity Heritage Library.
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