No. of Recommendations: 1
"I am uncertain whether to automatically reinvest dividends and capital gains from my mutual funds or not. I have done both at various times. I am especially uncertain about the monthly dividends from bond funds. We don't need the income from them, but I have been letting the divs go into our money market account instead of reinvesting. Opinions would be appreciated."

As Paul noted, whether you are talking about taxable or tax advantaged accounts is an important consideration.

What are the issues?

1) Paul is correct that reinvesting dividends, in a taxable account, can be a bookeeping pain in a taxable account. Of course, you can choose to use the "dollar cost averaging" method for paying taxes when you cash in, which should be more reasonable with bond funds, which tend to have their NAVs go up and down, and only moderately changing, than stock funds, where you expect, given enough time, for the shares you buy later to be at higher prices than shares you bought earlier (so you would want to use an accounting method that lets you sell first the shares with the least capital gain). Personally, I don't let extra bookeeping affect my decisions.

2) Rebalancing. Again, this is more of an issue for taxable accounts. If you rebalance periodically between different funds, say stocks and bonds, if you do this by selling shares, there is potential for capital gains on which you have to pay taxes. If, at least for some of the rebalancing, you use dividends that have been paid directly into your money market, you can avoid at least some capital gains taxes from rebalancing.

3) Market timing. If you reinvest dividends on a schedule, instead of choosing when to do it on your own, you avoid trying to guess the market (a notoriously losing proposition, whatever the husslers claim). On the other hand, to contradict what I just said completely, many of us are not buying shares in bond funds while interest rates remain historically low, and avoiding reinvesting dividends in bond funds is following the same caution. The thing is, what do you do with the money. My preference for CDs over bond funds in the current interest rate climate is based on cold calculation. Letting the money sit in a brokerage Money Market gets you a lot less than a 5-year CD, and that makes just putting the money back into the bond fund, even if the shares do decline in value, more likely to be a winning strategy.
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