Dividend investment plans not so simple

It’s just easy, it’s automatic or you might say it’s dumb and lazy.

The August company reporting season is now over and listed companies have announced their final dividends for the 2019-20 financial year. Many companies, especially banks, are preserving cash on their balance sheets.

So it’s no surprise we are seeing the re-emergence of dividend reinvestment plans (DRP), including some with discounts as companies try to retain cash and build equity.

Shareholders are currently receiving communications from companies asking whether they would like to enrol for the DRP for the forthcoming dividend payments: should they?

I am always surprised by how many of my clients are inclined to automatically sign up for DRPs, both for their direct security holdings and with managed funds.

I accept it does make sense in some circumstances — for example, for time-poor investors who want a “set and forget” ­approach or for smaller diversified investments.

Likewise, it might also be attractive to reinvest distributions — for example, closed managed funds typically of unlisted assets when there is no other ready or likely opportunity to invest more in the product.

But it doesn’t make much sense to me that investors who thoughtfully consider their risk, their asset allocation, their portfolio construction and each and every line item in their portfolio, happily abrogate the pricing and timing decision of adding capital to an investment just because they already hold it.

When investors say that they “don’t need the income” so it’s easier just to reinvest, I respond by saying then let’s think about other options for that income.

Why would each January and July be the best time to invest more in each existing managed fund regardless of the asset class and regardless of the point in time in the economic and financial cycle? It isn’t.

It’s just easy, it’s automatic or you might say it’s dumb and lazy.

The worst outcomes I have seen, particularly with higher income-generating investments, is that portfolios become increasingly concentrated to particular funds, sectors and stocks.

Investments that started as a sensible 5 per cent of a portfolio become a concentration risk at more than 10 per cent of a portfolio. Sectors that were benchmark weight or less become double benchmark weight.

When enrolling for DRPs, my advice is to do it just as carefully as you undertake the initial purchase decision and review that decision at least annually.

Sue Dahn is a partner at Pitcher Partners and a member of the Barron’s Australia’s Top Financial Advisors List for three years.