After Scottrade got out of the commission free / low expense ratio ETF game last August, investors didn’t have much reason to choose Scottrade over other brokers. Last week Scottrade announced a new “Flexible Dividend Reinvestment Program” to get back in the game. Does this new “FRIP” feature put Scottrade back on the radar for new investors looking for a broker?
Scottrade’s new “FRIP” (Flexible ReInvestment Program) is made to complete with a traditional “DRIP” (Dividend ReInvestment Program) currently offered by many other companies and brokers.
In a traditional DRIP, when a company pays a dividend the money from the dividend automatically goes towards purchasing more shares of the stock (generally with no commission). This makes for a great way for new investors to take advantage of compounding interest, dollar cost averaging into a position and building up their portfolios over time.
DRIPs were great for new investors to simply “set and forget” a portion of their portfolio and let time and compounding interest work for them. With a DRIP, as you get a dividend, you buy more stock, as you buy more stock you get a larger dividend, as you get a larger dividend you buy even more stock, which gives you an even larger dividend, etc. etc…
For example, consider $5,000 invested in Intel stock today. At $25 per share, that buys you 200 shares. Lets assume next quarter Intel would pay you a dividend of $0.25 per share, for a total of $50 (200 shares * $.25 per share). That $50 would go directly toward buying more Intel stock, in this case it would buy you 2 shares. Now you own 202 shares. Next quarter your dividend would be a little larger, and you would buy an additional 2 shares. Eventually the dividend would buy 3 shares at a time, then 4, then 5…and your portfolio would really start to grow exponentially. Over the course of your investment career, you would amass quiet a large position. If fact, assuming Intel’s share price and dividend stay constant, with the example above after 20 years you would end up with 443 shares, at a value of over $11,000. This is without any additional investment or increase in Intel’s share price!
So this investment strategy really adds up.
However, Scottrade has never to my knowledge offered a DRIP, despite their competition offering them for years. Scottrade experimented in the last few years with commission free ETFs that were at the time the cheapest ETFs on the market. But those never really took off and were liquidated in August 2012.
Since then, Scottrade really didn’t have much going for it. Today they are trying to get back in the game.
Scottrade’s FRIP works a little bit differently than a traditional DRIP. In a traditional DRIP, all dividends received must go back into the company’s stock that paid those dividends (like our example above, Intel dividends must buy more Intel shares).
But in Scottrade’s FRIP, your dividends from selected securities go into a separate “pool”, and you set up what you want that accumulating “pool” of money to automatically buy at scheduled intervals. Any purchases from that pool are commission free.
Lets take a look, shown below is my Roth IRA, which is set up through Scottrade:
(click to enlarge)
Those are 5 dividend paying securities that I own in my Roth IRA (Don’t consider my asset allocation as any type of investment advice!). Using the column on the far right, you select whether you want the dividends from each security to be eligible for the FRIP program. If you were dependent on some dividend income (say, in retirement) you would not want those dividends included.
So, if I selected those 5 securities above to be eligible, all dividends paid by those stocks/ETFs would go into a special “pool”, that you can set to automatically buy securities quarterly or monthly (see below).
Note, I am not actually setting up my FRIP with the securities above. I just wanted to show the versatility that this program has. You can select from many different ETFs (even ones that you do not own), and individual stocks (even ones that you do not own and do not pay dividends).
You can select up to 5 securities to be automatically purchased at scheduled intervals.
And that’s all there is to it. Investments made in the 5 securities selected above will be made automatically, every quarter, commission free.
This type of program has several distinct benefits over traditional DRIPs.
In a traditional DRIP, it is very easy to have your portfolio become overweight with a particular stock. Consider our Intel example above. Over time, your position in Intel grows exponentially, and if your other investments do poorly or you do not diversify into new investments, Intel may become a significant part of your portfolio.
A general rule of thumb that I like to follow is that no individual stock should make up more than 5% of your portfolio. With a DRIP, that rule could easily be broken over time.
But with Scottrade’s program, you can spread out your dividends to be reinvested in a wide variety of securities and even diversified ETFs, making keeping your portfolio in balance much easier.
Really, nothing stops an investor from having a strategy like this if their broker was, for example, Vanguard (or another brokerage with commission free ETFs).
If you have a broker that offers commission free ETFs, you can use dividends you collect from all your investments to buy any commission free ETF for free. However, it can not be set up to do automatically like Scottrade’s FRIP. So, as long as you check out your account a few times a year, you can create similar results with nearly any broker.
Scottrade’s FRIP program is great in theory, but unfortunately it fails in practice.
Scottrade’s FRIP program does have some downsides that makes this program almost ineffective for new investors or if you want to reinvest into a security with a high share price. The following quote comes from Scottrade’s FAQ section:
“How much money has to be in my FRIP™ account before trades will be made?
That depends on the number of securities you select, the price of each security and the percentage of your FRIP™ balance that you allocate to each security. In general, the more securities you have in your FRIP™ account, the more money you will need to accumulate from dividends for trades to occur. In addition, if you allocate low percentages to high-priced securities, you might have to accumulate substantial sums in your FRIP™ account before a trade will take place. For example, if you designate 10 percent of your FRIP™ balance to a stock trading at $200 per share, you will need at least $2,000 in your FRIP™ account for any purchases to be made. If you designate 5 percent to a stock trading at $400 per share, no trades would occur until you have at least $8,000 in your FRIP™ account.
Is there a formula I can use to determine the minimum needed in my FRIP™ account before trades will occur?
Yes. Divide the share price of each security by the allocation rate you set. The highest number generated by a security represents the minimum amount you would need before any trades can take place.”
If you have set up a small allocation of the dividends to reinvest into a security with a high share price, (like we showed above with Google as one of the choices at 15%). You need to accumulate a large amount of dividends before any purchase is made. In fact, if you have Google selected at 15% allocation, you would need over $5,700 in accumulated dividends before your first purchase is made. ($862 per share divided by 0.15). For any investor, that is a considerable amount of dividends, and could take years to accumulate if you are just starting out.
Consider a new investor who just opened a Roth IRA with $5,000. They invest that $5,000 into an S&P 500 index fund, like SPDR’s S&P 500 fund (ticker: SPY).
SPY currently pays out a quarterly dividend of $0.69 per share each quarter. $5,000 would buy 30 shares of SPY today, so the investor can expect a dividend of about $21 per quarter, or $84 per year, which means that they would not be able to buy an additional share of SPY for over 2 years!
So security selection is of utmost importance using this program. You can not choose a security with a high share price unless you are receiving a large amount of dividends.
For this reason, new investors really need to set up this program with only 1 or at most 2 securities with a relatively low share price in order to reap the benefits of dividend reinvestment. I am currently working the next Fund Spotlight Series, which will focus on diversified ETFs with a low share price, so investors can better take advantage of this dividend reinvestment strategy.
UPDATE: The Fund Spotlight Series can be found here: “Low Price, Diversified ETFs for Dividend Reinvestment”
For investors just starting out, if you truly want to participate in dividend reinvestment, look into Mutual Funds that offer automatic dividend reinvestments. Scottrade (and nearly every other brokerage) offers this with mutual funds.
Because mutual funds allow you to buy fractional shares, any dividend, no matter how small, can immediately contribute to dividend reinvestment. For new investors, this is the best route to go to truly see results.
The idea for a flexible dividend reinvestment program is a very good one. For an investor with a decent amount of money already invested, this is of tremendous use.
However, for new investors the program is nearly useless if you do not choose your investments wisely.
Since the program is nearly useless for new investors, I stick with my recommendation of new investors using a brokerage like Fidelity, Vanguard, Charles Schwab or even TD Ameritrade because of the wide selection of commission free ETFs and Mutual Funds.
For investors with larger accounts, the results of Scottrade’s FRIP can be easily emulated by using your broker’s offerings of commission free ETFs. The only benefit this program has is that you can set up automatic purchases. So if you are bad at remembering to investor your dividends, this program may be for you.
In the end, it is a valiant attempt by Scottrade to get back in the game, but I just don’t see it as a game changer in the industry.
For investors looking for more information on Scottrade’s new program, here are some links: