As a long-term investor, I tend to automatically reinvest any dividends that my investments throw off: it allows you to put that money to work as soon as you can, without having to think about it. And as an added bonus, since you’re reinvesting those small drips of money over time, it would seem to help improve the odds that you’re not buying too heavily at market peaks.
So is that the best strategy for most investors?
According to Christine Benz, director of personal finance at Morningstar, it really depends on what you’re trying to achieve. “If you’re a long-term investor, it’s probably a good idea,” she said. “Reinvesting dividends helps you obtain shares at varying price points. And fund companies and brokerage platforms have provided increasingly sophisticated tools to help you track cost basis.”
Your cost basis is the amount you paid for your investment, after factoring in items such as dividends, capital distributions, or stock splits. When you sell a taxable investment — say, shares of a stock or a mutual fund in a regular brokerage account — this figure is needed to calculate your capital gain or loss.
Other benefits: You may not have to pay commissions when you reinvest dividends into individual stocks or exchange-traded funds, which are essentially index funds that trade like stocks (and usually cost money to buy or sell, though many online brokerages now waive those costs).
Reinvesting dividends also makes it easier to track the true return of a security, said Mitch Tuchman, chief executive officer of MarketRiders, an online service that helps investors build and track portfolios of E.T.F.’s. “If I buy BND and all dividends are reinvested, I know exactly my return without having to look at the cash dividends and add back in,” he said, referring to the Vanguard Total Bond Market E.T.F.
But some investors may decide to forgo reinvestment, including retirees. “Taking and spending dividends — or pushing them into a money market-cash account — can be a good strategy for a component of a retiree’s income,” Ms. Benz said.
Some people may chose to let their dividends accrue in a cash-like account so that they can use that money to rebalance their portfolio back to their target allocations at a later date. In other cases, investors may simply not want to add more money to a particular position.
And, in years past, investors with money in taxable accounts may have also found it easier to avoid automatic reinvestment because every time that money is reinvested, it generates a new “tax lot,” or a new group of shares that need to be tracked for tax purposes, and which can affect your cost basis.
“The complaint has always been that tracking cost basis was very cumbersome,” said Lyle Benson, a certified public accountant and financial planner in Baltimore. “You’d have to keep track of every time you got a dividend and reinvested it.”
But now, new tax rules require brokerage firms to track and report your cost basis to the Internal Revenue Service, so this task should become more manageable. The rules are being phased in over three years: starting in 2011, the cost basis of stock investments bought that year and in future years will be reported to the I.R.S., and in 2012, the same will happen for mutual funds, exchange-traded funds and dividend reinvestment plans. Fixed-income investments and options will follow in 2013.
Do you reinvest your dividends? And do any brokerage firms that you have worked with make reinvestment difficult?
Article source: http://feeds.nytimes.com/click.phdo?i=78148bd5d7a70d269a3c50a0135b6118
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