Investing: Breeding wealth

When Claymore Investments announced that it was adding a DRIP to its ETFs, you might have wondered what the alphabet soup was all about.

The letters get confusing. But if you’re a small investor or just starting out, the new combination of ETFs and DRIPs may be just what you need. To understand why, let’s peer behind the letters and consider what each product brings to the table.

ETFs, or exchange-traded funds, operate like low-cost mutual funds. But unlike mutual funds, ETFs trade on a stock exchange, just like stocks.

The good thing about ETFs is that they cut the management fees you pay to an absolute minimum — in most cases, less than a quarter of what you would pay for an equivalent mutual fund.

The bad thing about ETFs is that you have to pay a broker’s commission every time you buy or sell them. The broker’s commission isn’t huge ($29 is typical at many of the bank-owned discount brokers), but they can chew up a big part of your cash if you’re investing a couple of hundred dollars every month.

Now consider DRIPs — or dividend reinvestment plans, as they’re more properly called. DRIPs allow you to buy stock in a company andreceive your dividends as additional shares, rather than as cash. This allows you to avoid paying a broker’s commission. DRIPs have long been offered by companies, including Bank of Montreal and Canadian Tire, as an inducement for long-term shareholders to acquire more shares. But Claymore’s program is the first that marries an ETF to a DRIP.

If you’re just beginning to build a portfolio, the combination can result in handsome savings. Say you own 1,000 shares of the Claymore CDN Dividend Income Achievers ETF. Your most recent monthly dividend cheque would have amounted to a mere $75 (7.5 cents per share). If you wanted to use that money to buy more units of the same ETF, you would ordinarily be hit with a broker’s commission of $29 — nearly half your dividend. By comparison, if you used Claymore’s DRIP program, all of your $75 dividend would automatically go to buy more shares of the fund. Over a year you would save nearly $350 in brokers’ commissions.

If you’re not familiar with DRIPs, don’t feel bad. They’ve faded in popularity in recent years as brokerage commissions have becomecheaper. But even experienced investors should check out the list of DRIP programs at cdndrips.blogspot.com. You’ll find surprising deals. Some companies offer discounts on shares bought through DRIPs. RBC, for instance, knocks 3% off the ticker price. For long-term investors, those savings add up.