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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.
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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.

I would reinvest them. Automatic reinvestment is essentially dollar-cost averaging.
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Keep in mind that even when you re-invest gains/dividends, they are income to you which immediately turn arojnd and use to purchase new shares. You don't say if this will be held in a taxable account or and IRA. If taxable remember 1) that will owe taxes on the distributions and 2) your re-invested dividends INCREASE your basis in the fund.
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I would not recommend reinvesting the dividends/ST cap.gains.

Let it go into a MMF, then rebalance annually.

buzman
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Unless I misunderstand the definition of "basis" in the fund, wouldn't reinvesting dividends at a reduced price from the original purchase (because the per share price has since declined) result in a LOWER basis?
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Yes - if the unit price went down and you used your dividend to puchase a few more shares then your average price per share would be lower, this is the essence of dollar cost averaging. However, your overall dollars invested in the fund would be ever increasing which will come into the tax picture when you eventually cash out and settle up with the IRS. Lets say you intially purchase 100 shares at $10 each and thus have $1,000 put into the fund. Then later their NAV has gone down to $9 at the time they pay a $90 dividend. So you get 10 more shares. So now you have 110 shares valued at $9 each, equal $990 total. If you closed out right now, you would have a tax loss of $100. You have spent $1,000 initially plus another $90 later so have invested $1,090. You sold for $990. So you lost $100 as far as IRS is concerned. Your overall basis was increased from $1,000 by the $90 dividend that you used to buy more shares.

Lets say you don't sell out and keep your 100 shares. Year end rolls around so you pay taxes on the $90 dividend you received. Even though you didn't literally receive it, you essentially did and then turned right around and used it to buy more shares.

Time goes on and the NAV has increased to $11 per share by the time they declare another dividend, $110 this time. Your $110 dividend will buy 10 more shares, so now you have 120 shares at $11 each, so your total account value is now $1,320. This year you will pay taxes on the $110 dividend just like before.


So later you decide to close out your position. By now the NAV is $12, so you 120 shares are worth $1,440. Your investment is your $1,000 initially plus the $90 dividend, plus the $110 dividend for a total of $1,200. You sell for $1,440 so you have a gain of $240 to pay cap gains taxes on. Note the taxes you pay on the two dividends are a separate matter.

Hope this helps....
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I am uncertain whether to automatically reinvest dividends and capital gains from my mutual funds or not.

The big problem with reinvesting dividends comes at tax time - if you have sold some or all of the fund. Not only do you have to keep track of each reinvested dividend, as an addition to your cost basis for the fund, you have to know how much was reinvested in the past year and what proportion of the total value for the sale this is. Reinvested dividends over the year preceding the sale are considered to be short term gains/losses, taxable at your normal tax rate. Dividends reinvested more than a year ago receive the long-term capital treatment, usually a 15% tax rate (depending on your AGI).

KP
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Thanks for the very good explanations and commentary! It is now clear why it is better to let the divs go into the MM in taxable accounts, and just rebalance from time to time.
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Author: blearynet | Date: 4/26/05 7:52 PM | Number: 45791
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.

I noticed that you cross-posted this from the Bond-Fixed Income board. Here is my reply from that board:

http://boards.fool.com/Message.asp?mid=22414066

Russ
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KP said: The big problem with reinvesting dividends comes at tax time - if you have sold some or all of the fund. Not only do you have to keep track of each reinvested dividend, as an addition to your cost basis for the fund, you have to know how much was reinvested in the past year and what proportion of the total value for the sale this is. Reinvested dividends over the year preceding the sale are considered to be short term gains/losses, taxable at your normal tax rate. Dividends reinvested more than a year ago receive the long-term capital treatment, usually a 15% tax rate (depending on your AGI).


If you keep reinvesting dividends like in DRIPs over enough years don't you need to keep three tax separations, one for dividends paid in the last year, one for capital gains for years 1 to 5 and capital gains for stocks held over 5 years? I get a bit confused, everyone seems to say this is easy but it looks a bit complicated to me.

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I get a bit confused, everyone seems to say this is easy but it looks a bit complicated to me.

It's sort of complicated and hugely a pain in the butt, IMHO.

rad
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If you keep reinvesting dividends like in DRIPs over enough years don't you need to keep three tax separations, one for dividends paid in the last year, one for capital gains for years 1 to 5 and capital gains for stocks held over 5 years?

Why 5 years? I only know of short-term (<1 year) and long-term (> 1 year) .

Barbara
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>> Why 5 years? I only know of short-term (<1 year) and long-term (> 1 year) . <<

There used to be an "extra-special" treatment of "very long term" capital gains held five years or more.

That is no longer the case; now anything held for more than a year gets the best tax treatment.

#29
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It's sort of complicated and hugely a pain in the butt, IMHO.

There's a reason I only use mutual funds in accounts where I have no other choice (403(b) in my case). Dealing with reinvesting dividends in a taxable account is a hassle which, IMHO, is just not worth it in these days of very low comissions.

--B+C
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