If you’ve ever bought a stock or mutual fund, this question will eventually come up: Should I Reinvest Dividends? (and Capital Gains for Mutual Funds). There’s no right or wrong answer, but this will outline the case for and against reinvesting your dividends.
The case for reinvestment:
- Dividend reinvestment is automated. There’s no thought into if/when to invest the money, the dividends and capital gains roll right back into the investment that generated them. It is simple
- Dividend Reinvestment is fee-free. There’s no cost for dividend/capital gain reinvestment. This is becoming less of a benefit with fee compression in the industry, but still a positive.
- Less idle cash. Not reinvesting dividends/capital gains generates a cash position in your account. This idle cash is earning a lower return than invested funds.
The case against reinvestment:
- Control: Some investors like to control their asset allocation more closely. Automatically reinvesting into a stock/mutual fund could create a transaction cost of selling that stock/fund to buy another stock/fund.
- Tax Liabilities: If your stock/mutual fund is held in a regular brokerage account, it is generating dividends and capital gain distributions that the account owner is required to report as income. Income = taxes owed.
- Distribution Needs: If you need to make withdraws from your accounts on a regular basis, having your dividends/capital gains settle into cash makes it easier to to handle distributions since there are fewer sale needs.
So what does the Shirt’s household do? Both
Funds Held in a Retirement Account: We’ve chosen to reinvest dividends and capital gains. These reinvestment automatically purchase more of the stock/mutual funds that I own without me having to think about it. There are no current distribution needs and I’ve managed asset allocation primarily through new contributions.
Funds Held in a Regular Account: No dividend reinvestment. I’ve actually gone back and forth on this, but have spent more time with dividend reinvestment off than on. Early retirement is on the immediate horizon and we will have regular distribution needs. Having dividends paid into the account will help with our cash needs and slow how quickly we draw down cash held for the current year’s living expenses.
Fractional shares used to create a tax headache when I sold and went to file, but fortunately brokerage accounts automatically import that information over to tax software. Fidelity also has a slick interface to move the lowest cost basis shares to a donor advised fund when we look to contribute. Transaction costs are now down to $4.95/trade, which is the lowest of my investing lifetime. Its not a huge cost if I decide I do want to buy more of a specific company or fund.
Do you have an investment question? Please reach out to me or comment below!