Many investors sign up for synthetic Dividend Reinvestment Plans (DRiPs) at discount brokers to save on trading commissions. With a synthetic DRiP, an investor can reinvest dividend payments in whole shares and have the leftover amount deposited as cash in their account. Let’s take an example. Investor John owns 1000 shares of ABC Corp. (ABC), which pays a quarterly dividend of $1.25. ABC Corp. is currently trading at $100. Since John had signed up for a synthetic DRiP on ABC Corp., his broker purchased 12 shares of ABC Corp. with a recent quarterly dividend payment of $1,250 and deposited another $50 into John’s account. This arrangement is beneficial from John’s point of view because he was able to increase his investment in ABC Corp. without paying a trading commission.
While DRiPs are usually a good thing, investors need to pay attention to the hidden costs they are incurring when they sign up for synthetic DRiPs on US Dollar stocks or Exchange-Traded Funds (ETFs) held in registered accounts such as RRSPs and TFSAs at discount brokers that do not segregate US Dollar and Canadian Dollar holdings (TD Waterhouse would be an example). Investors are probably aware that US Dollar dividends are converted to Canadian dollars at a rate that is typically 1.5 percent higher than the spot rate. But if you had signed up for a synthetic DRiP, the Canadian dollar dividends are again converted to US Dollars at a rate that is 1.5 percent higher than the spot rate and used to purchase whole shares of a stock or ETF. In effect, investors who are DRiPping US Dollar stocks or ETFs in registered accounts could be paying as much as 3 percent in foreign currency conversion charges.
A recent post on Canadian Money Forum provides an estimate of the hit from DRiPing US Dollar stocks in a RRSP account. Client received US$325 worth of US Dollar dividends out of which US$219 was DRiPped into shares and C$96.50 was deposited as cash. An exchange rate of 0.9645 for the converting US dollars to Canadian dollars. If no currency conversion charges were applied on the DRiPs, client would expect to receive $102 as a cash deposit. Instead he received $6 less. In other words, it cost C$6 to DRiP US$219 worth of shares or 2.8 percent.
What you can do about it
Fortunately, discount brokerage clients who are hit with double currency conversions on US Dollar DRiPs in registered accounts have a few options. If your broker allows segregation of US and Canadian dollar holdings, make sure your US Dollar denominated holdings are held in the US side of the account. If your broker does not offer segregated accounts, take a long hard look at whether synthetic DRiPping is worth the additional currency conversion charge. The break-even point for converting currency with the Norbert Gambit and then purchasing shares yourself is $2,000 (assuming 1.5 percent currency conversion charge, 2 trading commissions for the Norbert Gambit and 1 trading commission for the buy order). Therefore, a rough thumb rule would be that it’s better to reinvest on your own if you receive more than $2,000 worth of dividends. If you would really really like to implement synthetic DRiPs but the costs bother you, consider moving your accounts to a broker that does segregate holdings in registered accounts.
It is likely that clients at all discount brokers, even those that currently offer segregated USD registered accounts, charged double currency conversion fees on US stock DRiPs in the past. I hope that clients would raise this issue with their brokers and demand why currency was converted twice in synthetic DRiPs and what the brokers are going to do about it.
