Q: I have recently bought NAB shares. In reports of the bank’s half-year results last week, I read that it is offering a dividend reinvestment plan with a 1.5 per cent discount. This seems like a good way of increasing my stake. Are there any catches?
A: A dividend reinvestment plan is an offer by the company to issue new shares to shareholders in lieu of a dividend payment. DRPs certainly have their appeal: new shares are issued free of brokerage; and in this case the discount means you are getting a good deal.
DRPs can be viewed as a form of dollar cost averaging. By electing to receive additional shares instead of a cash payment, you are acquiring new lots of shares on a regular basis. By “averaging in” in this way, you remove timing risk from the investment decision.
From a tax point of view, the Australian Taxation Office treats the arrangement as if the investor had received a dividend and then used the cash to buy additional shares. So it is still taxable income.
On the capital gains tax front, each parcel of shares acquired in a DRP has a cost base for calculating CGT – the price paid for the shares and any costs involved in the acquisition. This can make management of the holding more complicated but should not really be a hindrance.
Despite the benefits, some financial planners recommend that their clients avoid DRPs. They prefer to see them accumulate dividends in a cash account and then purchase new stock after making a review of the performance of their portfolio and re-assessing their investment goals.
Most private investors hold only a small number of stocks, which creates concentration risk. Planners who opposed DRPs would say they perpetuate concentrated portfolio holdings, whereas most private investors should be aiming for a higher level of diversification.
Another issue to consider is whether you can rely on the company to maintain its DRP and the discount. NAB has a track record of offering a discounted DRP but it is not uncommon for companies to turn their DRPs off and on, and adjust or drop the discount, to suit their capital management requirements.
If you do make use of the DRP you will be in good company. The big banks report that they have DRP participation rates of around 30 to 40 per cent.