Saving for retirement is a top financial goal for many Canadians. With powerful tax advantages, Registered Retirement Savings Plans (RRSP) are perhaps the most important component of any retirement plan. An RRSP not only enables you to save up for retirement, tax deferred, but also allows you to earn tax-sheltered investment income like interest and dividends. In general, the sooner you start – and the higher your savings rate – the less time you’ll need to reach your retirement financial goals due to the power of compounding.
Compounding is a process where investment earnings, from either capital gains or interest, are reinvested to generate additional earnings over time. Compounded growth occurs because the investment generates earnings from both its initial principal and its accumulated earnings over time. Essentially, you’re earning interest on your interest, and over time, that can really add up.
Dividend Reinvestment Plans (DRIPs)
One of the best ways to take advantage of compounded growth is through a Dividend Reinvestment Plan, or DRIP. For investment providers that offer these plans, a DRIP automatically reinvests the cash dividends you earn on investments – like stocks, exchange-traded funds and some mortgage investment corporations (MICs) – into more shares or units of your investment.
DRIP Benefits
DRIPs can have immense benefits if well-planned. The most important thing is to pick a strategy – or better yet, a mix of strategies – that works for you.
A DRIP provides investors with the following advantages:
Dollar-cost averaging. When you dollar-cost average into a fund or asset, you are investing the same amount of money at regular intervals over time. This way, you average out the price at which you buy into an investment as it moves up or down over a long period. This system is popular because it takes the emotion out of investing and ensures you keep investing regardless of market sentiment.
Compounding returns. Compounding allows you to earn income on your income and magnify your returns over time. Financial experts refer to this as the “miracle of compounding.” In the long run, investors who opt for DRIPs end up owning a greater share or percentage of the investment vehicle.
Time is the key to accelerating the income potential of your principal investment. You need to be patient before you can enjoy financial freedom. Apart from that, DRIP teaches a valuable lesson of controlling your emotions, especially during economic downfalls or periods of financial instability.
DRIP Drawbacks
Depending on the investment vehicle, the reinvestment may acquire additional shares at an inflated price if the share or unit prices are subject to market movements. This isn’t a problem when investing in MICs because the shares aren’t publicly traded and do not fluctuate like stocks. If investing through an RRSP while utilizing a DRIP program, investors are able to defer taxes on their dividend earnings. Reinvesting the full dividend amount via a registered account allows you to maximize the growth of your investments while postponing your tax obligations.
In numerous ways, DRIP or share repurchases may be better than cash dividends, depending on a number of factors. However, DRIPs vary across companies and investment funds. Some may allow shareholders to buy shares based solely on their dividends, while others enable optional and additional cash purchases on top of the dividend reinvestment.
Mortgage Investment Corporations (MICs)
Like other assets, MICs can be a key part of your registered investment portfolio. They can provide recurring dividend payments that can be cashed out or reinvested for compound growth. Unlike the dividend you receive from a publicly-traded stock, which is a distribution of the company’s earnings, MICs distribute dividends generated by interest and fees collected from mortgage borrowers. And unlike stocks, your MIC shares are not exposed to share price movements and the volatility that usually accompanies public markets. Because MICs are qualified investments allowed in RRSPs, they offer the benefits of tax-sheltered compound growth as you save for retirement.
Don’t underestimate the power of your retirement savings plan. If you apply the power of compounding, you can look forward to achieving your financial goals that much sooner.
Contact CMI to learn more about our DRIP program and see why CMI MIC Funds make mortgage investing easy.
