The Smith Manoeuvre questions keep coming in. For those of you new to the Smith Manoeuvre, it’s essentially a leveraged investing strategy where you obtain the capital by borrowing against your house. You can read all about it here.
Sounds risky? I’m not going to sugar coat it, the strategy is certainly risky. Borrowing to invest will not only amplify your gains but also your losses. Depending on your temperament, the feeling of generating a loss can be far greater than the highs of gains.
Being the wild and risky type (i’m being sarcastic, I would consider myself a conservative investor), I started a leveraged dividend investment strategy during the peak of the market in 2008. It hurt a lot at first, but I stuck with the strategy and I am still collecting dividends from the portfolio.
Since my last article where a reader asked about capitalizing the interest (where the portfolio pays for itself), there have been a number of emails from readers with more questions. One reader asked if I DRIP the dividend stocks within my leveraged portfolio.
Here is the question:
I know you have extensive experience leveraging using the smith maneuver. I was wondering if you used a DRIP program for when cash dividends were paid out and could be reinvested in the shares you had. Other than some additional record keeping, are there any other issues with this idea?
Lets take a step back for a second. What is DRIP? It stands for Dividend Reinvestment Plan and in my case, setting up DRIP within a discount brokerage account is called a synthetic DRIP. When you call your brokerage and setup synthetic DRIP with a particular dividend stock, the brokerage will automatically purchase additional shares of that stock (without commission) when a dividend is paid out to your account. The catch is that the dividend needs to be enough to purchase 1 whole share – no partial permitted. If the dividend is not enough to purchase one share, then the dividend will be deposited as cash.
Adding to your portfolio commission free sounds great right? It is in theory, but there are a couple of trade offs, which are the main reasons why I don’t DRIP the positions in my Smith Manoeuvre portfolio.
- Tax Administration – In non-registered (taxable) portfolios, when you sell a stock, you need to know your adjusted cost base (acb). While calculating the ACB is simple if you buy 100 shares of XYZ at $10/share and close your position at a later time, it gets more complex if you are adding one or two shares of XYZ every quarter at varying prices. Essentially, in order to properly track ACB, you’ll need to track DRIP purchases for every stock position during every distribution (some pay monthly). To me, this is simply too much work. It’s easier to accumulate cash from the dividends and re-deploy at a later time.
- Control – Another benefit of accumulating dividend cash to re-deploy at another time is the ability to control which positions you add to. With DRIP, you have no control on the share purchase price as it is automatic when the distribution occurs. Letting the cash build allows me to create/build positions when stock valuations and/or yields are attractive. Here is an article on knowing when to buy dividend stocks.
In a tax sheltered account (ie. TFSA/RRSP/RESP), I think that DRIPing dividend stocks (or ETFs) is a decent idea especially since you can keep adding to a position on a commission free basis without the hassle of keeping track of your adjusted cost base for tax purposes.
What are your thoughts on DRIPing your stock positions?