Why is automatically reinvesting dividends bad in taxable?

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assumer
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Why is automatically reinvesting dividends bad in taxable?

Post by assumer »

In the past, I understand that you would have many more granular "costs bases" to keep track of.

So if dividends were distributed every month, for example, you'd have 12 different cost bases each year for relatively small amounts of money. As compared to sweeping it into a MM account and reinvesting yourself once every 6 months or so.

Issues I have are:
  1. You are therefore out of the market for longer while you are waiting for a large enough chunk to reinvest.
  2. With the new requirements that brokerages keep track of your costs bases for you, does it matter anymore? The brokerage will keep track of your cost bases.
  3. Firms such as Vanguard even have a "first-in-first-out" option so that they will always liquidate investments with the lowest cost basis if you want to simplify your life.
What am I missing here?
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VictoriaF
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by VictoriaF »

If you manage dividends separately you can use them for rebalancing. If stocks are high you put dividends into bonds, and vice versa.

Victoria
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assumer
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by assumer »

VictoriaF wrote:If you manage dividends separately you can use them for rebalancing. If stocks are high you put dividends into bonds, and vice versa.

Victoria
Oh okay that makes sense. For me I use only a single target-retirement fund for everything in every account, so I suppose that doesn't apply to me.
Code Commit
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by Code Commit »

Another "bad" reason may be that it could interfere with a TLH move and might trigger wash sale, if the auto-reinvestment happened 30 days before or after the TLH sale.
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Steelersfan
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by Steelersfan »

"First in first" out only gets you the lowest cost basis if prices increase steadily over time. If they go up and down (as surely they do) you will not always get the lowest cost basis using that algorithm.
leonard
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by leonard »

assumer wrote:In the past, I understand that you would have many more granular "costs bases" to keep track of.

So if dividends were distributed every month, for example, you'd have 12 different cost bases each year for relatively small amounts of money. As compared to sweeping it into a MM account and reinvesting yourself once every 6 months or so.

Issues I have are:
  1. You are therefore out of the market for longer while you are waiting for a large enough chunk to reinvest.
  2. With the new requirements that brokerages keep track of your costs bases for you, does it matter anymore? The brokerage will keep track of your cost bases.
  3. Firms such as Vanguard even have a "first-in-first-out" option so that they will always liquidate investments with the lowest cost basis if you want to simplify your life.
What am I missing here?
Keep it simple applies to tax lots too. The fewer the better.
Leonard | | Market Timing: Do you seriously think you can predict the future? What else do the voices tell you? | | If employees weren't taking jobs with bad 401k's, bad 401k's wouldn't exist.
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Artsdoctor
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by Artsdoctor »

Assumer,

There's no single answer that is best for everyone. Taxes are complex enough that I personally like to make things as easy as possible, so I prefer to batch dividends up and put the totals wherever my asset allocation suggests they belong. This year, it's meant that equity dividends have been flowing into fixed income side of things.

If you're inclined, you could choose Specific Lot ID for cost basis. There will be times when you want to sell shares with the highest cost basis, and there will be times when you might want to donate shares with the lowest cost basis. The idea is that it gives you a bit more control.

The one problem with choosing Specific Lot ID (at least at Vanguard) for your cost basis is that you will have to sell shares and not dollars. For example, if you want to donate appreciated shares to a charity from a fund that you've chosen Specific Lot ID in order to calculate your cost basis, you'll need to donate a specific number of shares (250 shares, as opposed to $5,000).

Take a look at the Wiki. It'll help explain the pros and cons of reinvesting dividends versus not, and the different types of cost basis calculations.
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ogd
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by ogd »

It's not as bad as it used to be, for sure. However, with your one fund investment you are underestimating the burden most people would face if they set up auto reinvestment. The tax lots generated each quarter would be:

1x the number of equity funds, plus
3x the number of bond funds

, whereas with manual reinvestment once per quarter you generate one or two at most, possibly rolled into a purchase or rebalance that you would have done anyway. Multiply by say 20 quarters and it adds up really quick.

Even if the tax tracking is automated, info about these lots still needs to make its way onto your tax return eventually, without errors in either turbotax downloading or your transcription. Your tax guy might want a little more money when presented with pages and pages of $100 purchases. Finally, you need to be ever more vigilent about wash sales, which means even reinvestment inside tax-advantaged accounts is a bad idea if you use the same funds in taxable.

And all that buys you is maybe 0.5% more in the market, on average, vs investing quarterly, meaning +0.03% or so returns. Not worth it to me, and certainly less than what you gave away in ER by using a single fund (which btw I have no qualms with).

Before the broker tracking reqs went in effect, it really was no contest. Auto reinvest was toxic to your sanity.
BanditKing
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by BanditKing »

You might need a portion of that dividend income to address any taxes as well, otherwise if you auto-reinvest you may need to sell a child or something to pay the tax man. You could always sweep it somewhere better than a MM that you might still liquidate if needed or when you do your regular rebalance.
gd
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by gd »

I don't think it is bad. I have no doubt that removing my behavior from the process has increased my wealth measurably. YMMV. Quicken or equivalent makes FIFO CGs trivial. It helps if you've been using it from the start.
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VictoriaF
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by VictoriaF »

gd wrote:I don't think it is bad. I have no doubt that removing my behavior from the process has increased my wealth measurably. YMMV. Quicken or equivalent makes FIFO CGs trivial. It helps if you've been using it from the start.
My behavior is finicky. I can't tell in advance what it would and would not react to, and thus I don't know which investment vehicles to remove it from. So far, un-reinvested dividends have not caused me behavior problems.

Victoria
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Artsdoctor
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by Artsdoctor »

Why would FIFO be your choice, out of curiosity? The first in may be the highest (or the lowest) cost, or somewhere in between. What is the advantage?
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assumer
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by assumer »

Artsdoctor wrote:Why would FIFO be your choice, out of curiosity? The first in may be the highest (or the lowest) cost, or somewhere in between. What is the advantage?
Oh, I just assumed (yeah, I know...) that if stocks have a positive expected value over time, then on average the FIFO would be the stocks with the most gained taken out. Also it's easier since I only have a single fund, and I expect that fund to have a positive return over 30 investing years. Yes, it's not optimal, but it's simple. Unsure how much I'd "lose" by not doing it.
Dulocracy
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by Dulocracy »

I actually think it is good to reinvest dividends in the fund that spawned them. Why? That fund worked to get that money for me, so it deserves to keep it. (Or, in more rational words: dividends are a part of the benefit of the fund. I want to compare funds annually and know that the mid-cap index grew because of the mid-cap index, not because I added dividends from another fund.)

When I do rebalance, I do it with new money. To me, dividends are not new money but money the fund earned.
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.
Karamatsu
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by Karamatsu »

Taxes on reinvested dividends really aren't a big deal now that the broker is tracking cost basis... in a surprising move the IRS actually understands that people do this kind of thing, so they let you enter VARIOUS for the purchase date (See Instructions for Form 8949, pg. 3). The only thing you have to do is be sure to separate short-term and long-term transactions, which the broker statements usually do anyway. It's easy compared to something like, say, foreign tax credit reporting.
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joe8d
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by joe8d »

Dulocracy wrote:I actually think it is good to reinvest dividends in the fund that spawned them. Why? That fund worked to get that money for me, so it deserves to keep it. (Or, in more rational words: dividends are a part of the benefit of the fund. I want to compare funds annually and know that the mid-cap index grew because of the mid-cap index, not because I added dividends from another fund.)

When I do rebalance, I do it with new money. To me, dividends are not new money but money the fund earned.
Yes. I reinvest all dividends.
All the Best, | Joe
stlutz
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by stlutz »

See this thread on how numerous cost lots can become a problem.

http://www.bogleheads.org/forum/viewtop ... st=1874069
knowmad
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by knowmad »

I just use average cost basis. I hardly ever sell anything anyway.
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joe8d
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by joe8d »

knowmad wrote:I just use average cost basis. I hardly ever sell anything anyway.
Yes. I've sold a dozen outside funds to convert to VG and always used ACB.
All the Best, | Joe
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Artsdoctor
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by Artsdoctor »

assumer wrote:
Artsdoctor wrote:Why would FIFO be your choice, out of curiosity? The first in may be the highest (or the lowest) cost, or somewhere in between. What is the advantage?
Oh, I just assumed (yeah, I know...) that if stocks have a positive expected value over time, then on average the FIFO would be the stocks with the most gained taken out. Also it's easier since I only have a single fund, and I expect that fund to have a positive return over 30 investing years. Yes, it's not optimal, but it's simple. Unsure how much I'd "lose" by not doing it.
In general, delaying tax payments as long as possible gives you the time to put more money to work. If your equity funds have a steady upward climb, then using FIFO would give you the highest possible capital gain at the earliest possible time. If you're willing to work a little bookkeeping, the Specific Lot ID allows you to sell the shares with the highest cost basis and donate the shares with the lowest cost basis (if you're inclined). I haven't really done the spreadsheet math, but even using Average Cost Method might be more beneficial than FIFO if you want to keep things that simplest. Just my opinion, and you may want to consult an accountant or read the Wiki on Cost Basis for more ideas.
KyleAAA
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by KyleAAA »

It isn't bad. It might make tax lost harvesting slightly more of a pain every once in a while, but probably not. FIFO doesn't mean lowest-cost shares are sold first, it means the first bought are the first sold, regardless of price. I reinvest dividends in taxable and just use average cost basis. Am I leaving money on the table by not TLHing on an annual basis? Maybe. But I think my savings rate more than makes up for it right now. Besides, I haven't sold a taxable share in years so it doesn't make much practical difference to me.
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Re: Why is automatically reinvesting dividends bad in taxabl

Post by ruralavalon »

Before retirement used average cost basis and reinvested all dividends. All rebalancing done in tax-protected or by new contributions.

After retirement still use average cost basis, and direct all dividends in taxable to MM fund and then to checking for living expenses. So never have any short term gains if shares from taxable are sold. All rebalancing done in tax-protected.

Works fine for us.
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