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Why you shouldn't "automatically" reinvest dividends
Silly me. From the title I thought it might be something about getting burned by wash sales when redeeming bond funds. (Since those funds typically pay dividends monthly, you're almost certain to have bought via reinvested dividends within 30 days of any redemption; if you redeemed at a loss you'll have a wash sale.)
As far as opportunity costs go - reinvesting dividends is only the most obvious case of making a decision to invest vs. spending now. But every day, doing nothing with your portfolio is doing something. You are, day by day, minute by minute, making decisions to (re)invest in what you already own, rather than invest in something else, or spend that dollar you have invested. This is why I'm a firm proponent of mark to market - saying that you haven't lost money because that bond will be worth its face value 10 years from now is neglecting the opportunity cost - what you could have done with the (now reduced) money you chose to leave in the form of a bond.
Doing nothing is making a decision not to invest in something that might provide a better return. Reinvesting dividends (automatically or explicitly) is making a decision not to invest in something that might provide a better return and not to spend the money. No real difference - the dividends are just more visible (and, I suppose, a bit more liquid).
Reply to @msf: the 'opportunity cost' issue is one of the primary reasons I threw this general article up for review. I have been guilty of hanging on to certain issues just because I rationalized that I was earning X% (e.g. 10%) dividend on cost. Well if that issue is only paying a 3% dividend based on todays share price and I could be earning say 5-6% for the same money on an alternative investment then maybe my money could be working harder for me. Granted a whole lot of other factors need to be included or evaluated but it is something to consider. Maybe 'expected future returns' deserve more attention.
Age old (or old age) dilemma? ... By the time you amass that fortune, the old bones are creakin & groaning: "Sometimes I'll receive correspondence from successful dividend growth investors who note the frustrating nature of compounding with dividend growth stocks - often, you're not loaded until you're an old man! They might have that $5 million fortune at the age of 70, but what they really wish they could do is take that $5 million and combine it with their 25-year-old bodies and stir up some mischief."
- Thanks Mark. This fella's got more than half a brain. Hits lota bases in article.
Yeah, there is that. Seriously though, with the increase in life expectancy and improvements in health care, the odds are that we will still be in pretty decent shape at 70, and able to spend money with the best of them. My wife can, anyway.
Come to think of it, I bought my first brand-new pickup five years after retirement, and didn't worry even once about the price. Thought that I owed it to myself to have at least one new pickup before it's all over!
Comments
As far as opportunity costs go - reinvesting dividends is only the most obvious case of making a decision to invest vs. spending now. But every day, doing nothing with your portfolio is doing something. You are, day by day, minute by minute, making decisions to (re)invest in what you already own, rather than invest in something else, or spend that dollar you have invested. This is why I'm a firm proponent of mark to market - saying that you haven't lost money because that bond will be worth its face value 10 years from now is neglecting the opportunity cost - what you could have done with the (now reduced) money you chose to leave in the form of a bond.
Doing nothing is making a decision not to invest in something that might provide a better return. Reinvesting dividends (automatically or explicitly) is making a decision not to invest in something that might provide a better return and not to spend the money. No real difference - the dividends are just more visible (and, I suppose, a bit more liquid).
Also, it is a healthy way to take profits. A good reason I'm still wearing my shirt with CGMFX.
- Thanks Mark. This fella's got more than half a brain. Hits lota bases in article.
Come to think of it, I bought my first brand-new pickup five years after retirement, and didn't worry even once about the price. Thought that I owed it to myself to have at least one new pickup before it's all over!