To reinvest or not to reinvest?

GregFromBoston

In previous portfolios I have worked on I have mostly been interested in long-term gains in nontaxable accounts. I have focused on total return, reinvested capital gains and dividends, and viewed transaction costs in rebalancing as a short-term tactical issue not worth extensive planning effort.

Currently I am building a taxable portfolio the main purposes of which are capital preservation and generating a modest stream of income. Should I be thinking about the reinvestment options any differently? I have seen both of the following positions advocated:

1) Look only at Total Return. Reinvest capital gains and dividends. Sell assets to generate income as necessary. Periodically buy and sell assets to rebalance.

2) Take all gains and dividends as cash in your sweep account. Take income from sweep account money market account as necessary. Reinvest selectively at scheduled rebalancing time.

With 1), it seems to me you get the maximum proportion of the total return of your investments, but lose something on transaction costs. This choice is also compatible with a loose rebalancing discipline. With 2), you fail to get the benefits to returns of reinvesting, but save money on transaction costs. Choice 2 is compatible with a strict rebalancing schedule (so that you don't let cash build up excessively), or a with a desire to gradually increase the cash stake.

Currently, I am splitting the difference and reinvesting capital gains while taking the dividends as cash. But I have no real rationale for this. It's more like I am using the two choices as "anchors" and making the comfortable choice right in between.

How do you folks handle this rather simple procedural issue?

gfb

bee

Hey Greg,

Thanks for sharing what sounds like a very common problem. If I might indulge you...what is the make up of your taxable portfolio? The reason I ask, I have a feeling some of us here could learn from the process you went through creating your taxable portfolio.

Thanks

paule

Greg, I have struggled with this problem since I retired. Since I do not need the income or capital gains to live, I decided to continue with reinvesting the capital gains and dividends and let the account grow.

paule

[Deleted User]

The user and all related content has been deleted.

hank

Following with interest as recently started periodic contributions to non-retirement mutual fund account. Opted to reinvest dividends/cap gains for max growth. Assumed custodian would compute a cost basis for tax purposes. Appears correct based on linked article, however, method of computation may not favor all. Was advised by my own custodian, they do the computation provided there have been no changes of ownership/registration or other extenuating circumstances.

Relevant excerpt: "Most reputable mutual fund companies will provide cost basis information for you when you sell your shares -- averaged according to the Single Category Method."

http://www.fool.com/personal-finance/taxes/2005/06/03/tax-rules-for-selling-mutual-funds.aspx

VintageFreak

I rarely "automatically invest". The reason is, it becomes that much harder to track cost basis.

I track buys in whole dollar amounts. Sells in whole shares.

Just look at estimated dividend payouts, approximate to whole dollar amounts and invest after distribution. Frankly I never even do that. I do my buys when I do my buys. It's also a healthy way of taking profits off the table. I'm not nervy about my CGMFX position only because I never re-invested a dime of reinvested distributions. When it really hits the depths, I will then put more money in.

GregFromBoston

Thanks to all who commented.

bee: I think I will discuss the portfolio construction in a separate thread. There are some fairly specific personal circumstances that have influenced my decision-making. I am still working on how to talk about the issues in a way useful to other people without disclosing more than I really wish to. Stay tuned.

paule, hank: Your choices sound appropriate for your situations. I appreciate the perspectives.

Maurice, VintageFreak: Thanks for the experience-based comments. I do want to keep things as simple and clear as possible. In years near historical averages for the portfolio, a significant portion of the gains will need to come out as income. In years with outsized gains, it is likely these will be unevenly distributed among the funds and I may not want to "buy high" by reinvesting automatically . Finally, since some of the funds are in fact allocation funds, the managers are already making rebalancing choices -- automatic from my perspective. So enough is happening automatically within the funds already. Making deliberate choices about what to do with those gains would seem to be the right way to go.

gfb

fundalarm

i reinvest in tax deferred and roth, and usually do not reinvest in taxable for above-mentioned simplicity of tax basis calculation. however, there are always exceptions. there is an aggressive frontier market fund that i reinvest - i let it grow organically without committing any more capital as it is very volatile, there are muni funds, and there is STD - Banco Santander, which has the benefit of a scrip dividend that is often taxed favorably.