Spending Dividends vs reinvesting and selling stock

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akushner23
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Spending Dividends vs reinvesting and selling stock

Post by akushner23 » Tue Dec 26, 2017 6:18 pm

Hello Everyone. My wife and I were lucky to inherit a stock portfolio a few years back. This forum as well as "The Bogleheads guide to investing" have been great resources for me to learn more about how to properly manage and add to the portfolio.

We have been using the dividends as income to support our living expenses. I'm curious if there would be any disadvantage to reinvesting all dividends and then selling 3% of the portfolio a year to cover the same amount that the dividends were bringing in. 3-4 stocks make up a very large percentage of the portfolio, so I'm thinking that by reinvesting dividends and selling shares of these large holdings every year I could lower the risk of a few stocks making up a large percentage of the portfolio. Any tax considerations? I'm thinking tax on capital gains/losses would be less then taxes on the dividends. Thanks so much.

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grabiner
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Re: Spending Dividends vs reinvesting and selling stock

Post by grabiner » Tue Dec 26, 2017 9:13 pm

Welcome to the forum!

You owe taxes on the dividends whether you reinvest or not, so there is no particular tax advantage to reinvesting dividends. In fact, the following situations are equivalent:

Receive $10K in dividends, spend the dividends, sell $10K of stock A to buy fund B.
Receive $10K in dividends, use them to buy fund B, sell stock A to spend $10K.

Either way, you owe capital-gains tax on the sale of stock A (for a gain of $10K minus the value of the shares on the date you inherited them), and dividend tax on the $10K dividend.

It is important to get your risk level right. Therefore, if you have more than 5% of your portfolio in any single stock, or too much in any one industry, or more stock than your risk tolerance, you should sell stock and pay any necessary capital-gains tax. If you don't need the money, you can use the proceeds of selling the stock to buy bonds, or buy other stocks which improve your diversification.
Wiki David Grabiner

dbr
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Re: Spending Dividends vs reinvesting and selling stock

Post by dbr » Tue Dec 26, 2017 10:44 pm

If you are trying to divest yourself of a concentrated stock position the first thing to do is NOT reinvest the dividends.

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Artsdoctor
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Re: Spending Dividends vs reinvesting and selling stock

Post by Artsdoctor » Wed Dec 27, 2017 6:43 pm

akushner23 wrote:
Tue Dec 26, 2017 6:18 pm
Hello Everyone. My wife and I were lucky to inherit a stock portfolio a few years back. This forum as well as "The Bogleheads guide to investing" have been great resources for me to learn more about how to properly manage and add to the portfolio.

We have been using the dividends as income to support our living expenses. I'm curious if there would be any disadvantage to reinvesting all dividends and then selling 3% of the portfolio a year to cover the same amount that the dividends were bringing in. 3-4 stocks make up a very large percentage of the portfolio, so I'm thinking that by reinvesting dividends and selling shares of these large holdings every year I could lower the risk of a few stocks making up a large percentage of the portfolio. Any tax considerations? I'm thinking tax on capital gains/losses would be less then taxes on the dividends. Thanks so much.
The answers above are accurate.

When a stock or stock fund pays a dividend, you have no voice in the matter. You're going to be taxed whether you need the money or not. The dividend may be 100% qualified or less. If it's 100% qualified, you're going to be taxed at the same rate as long-term capital gains.

There's no point in reinvesting your dividends if you're going to spend the stock. You mention that you're trying to "lower the risk of a few stocks making up a large percentage of the portfolio," something that most Bogleheads would support you on. There would really be no justification for reinvesting those stocks' dividends. In fact, you'd be generated more shares which is going contrary to your goals.

You mentioned that you inherited the stocks "a few years back." We've had a significant bull market for the past 8 years, but you probably know that the cost basis of those stocks you have was reset on the date of death. If you want to start slowing getting rid of those stocks, you'd want to take a close look at the cost basis and start selling those shares with the highest cost basis first, provided this would fit with your investment goals.

xmuppet
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Re: Spending Dividends vs reinvesting and selling stock

Post by xmuppet » Thu Dec 28, 2017 5:17 pm

There seems to be a prevalent misconception out there that you don’t pay taxes if you reinvest the dividends. In a taxable account that’s not so. In fact dividends are taxed like CG, with qualified dividends (based on holding period and the tax characteristics of the stock itself; eg dividends from REITs are never qualified) being taxed at the LTCG rate.

So I’d suggest just spending the dividends directly rather than reinvesting and possibly paying more taxes when you sell (or possibly taking a loss).

Gill
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Re: Spending Dividends vs reinvesting and selling stock

Post by Gill » Fri Jan 12, 2018 9:14 pm

xmuppet wrote:
Thu Dec 28, 2017 5:17 pm
There seems to be a prevalent misconception out there that you don’t pay taxes if you reinvest the dividends. In a taxable account that’s not so. In fact dividends are taxed like CG, with qualified dividends (based on holding period and the tax characteristics of the stock itself; eg dividends from REITs are never qualified) being taxed at the LTCG rate.

So I’d suggest just spending the dividends directly rather than reinvesting and possibly paying more taxes when you sell (or possibly taking a loss).
Qualified dividends are only taxed at the LTCG rate when the taxpayer’s LTCG rate happens to be 15%
Gill

HJG0989
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Re: Spending Dividends vs reinvesting and selling stock

Post by HJG0989 » Sat Jan 13, 2018 3:19 pm

This doesn't address your question, but I have a cautionary tale for you, OP.

My spouse and I each received an inheritance of stocks in 2009. We sold a few shares to buy a house and I sold some shares that were concentrated in one company and put it in a total stock market fund. The other stocks we let ride.

We now have more than a million in capital gains and can't really sell off the stocks without a huge tax bill. Meanwhile, the companies merge, spinoff, stocks split and we have to track the cost basis and pay attention to what is happening with the individual company's profitability.

If I could do over I would have liquidated early on and moved the money into index funds before the capital gains grew.

Just some food for thought.

mega317
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Re: Spending Dividends vs reinvesting and selling stock

Post by mega317 » Sat Jan 13, 2018 3:39 pm

HJG0989 wrote:
Sat Jan 13, 2018 3:19 pm
We now have more than a million in capital gains
Must be rough.

But it is a good post and a good point.

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