Is It Better to Reinvest Dividends?

[oldtoyota]

For my investments via Vanguard, is it better to reinvest the dividends?

My accountant once told me not to do that because of tracking. I can't quite recall why he said not to do it, and I'm not sure if what he said a year or two ago would still apply now.

Thoughts?

[LowER]

Replying just to make it easier to follow this post.  I've been wondering about this.

[secondcor521]

If it is a taxable account, then every time you reinvest dividends you create another lot.

When you go to sell, in order to properly calculate your capital gains or losses, you will need to know the basis of every lot involved in that sale.

Fewer lots make it easier to track.

See Bogleheads wiki on cost basis:  http://www.bogleheads.org/wiki/Cost_basis_methods

[kudy]

My first taxable investments were purchased this year, meaning the brokerage firm will do the accounting for me should I ever sell. I'd say he most important thing is understanding the different accounting methods and picking the one that makes the most sense for you.

[GreenGuava]

In a tax advantaged account (such as an IRA), just re-invest the dividends and re-balance as necessary.

In a taxable account, I suggest not reinvesting dividends - redirect them to your bank account or to a money market fund.  Then, when the dividends show up, use them as part of a re-balancing.  You have to pay the same tax on dividends whether or not you re-invest them right away, might as well use that to keep your asset allocation (and thus, risk) where you want it to be.

[sheepstache]

I think for Vanguard or for mutual funds in general it is not going to make a difference for tax or paperwork purposes.

Not reinvesting the dividends would make sense for the reason Green Guava gave.  However, there is also a psychological aspect.  You should ask yourself if you gain any benefit from having the extra control and whether you are likely to follow through.  The advantage of automatic reinvestment is the fact that it is a set-it-and-forget-it approach which protects against the temptation to spend the dividend income, forgetfulness when it comes to reinvesting, and potentially missing out on gains while reinvestment is delayed.

Oh yeah, and as Kudy points out there are two different accounting methods.  I'm only familiar with cash method.

[GreenGuava]

You should ask yourself if you gain any benefit from having the extra control and whether you are likely to follow through.

Good point.  If you're unlikely to follow through, and instead just keep the dividend in your bank account, it's better to let them reinvest automatically.  I was assuming - and I should have stated - that the person in question is making at least quarterly (the rate at which Vanguard funds tend to send dividends, at least for non-bond funds) investments.

[icefr]

I haven't been adding to my taxable funds at Vanguard for most of the last year, so I've been letting it reinvest automatically. I'm going to start contributing again soon, so I plan to turn off dividend reinvestment and manually invest in the dividend months vs letting the direct deposit automatically invest.

[oldtoyota]

Very helpful. Thank you, all!

What is the other method besides cash method?

I like the idea of using the dividends to keep the portfolio balanced. Good idea.

[secondcor521]

The other accounting method is the accrual method.  As an individual taxpayer, I believe (but am not sure) that you must use the cash method of accounting.  The accrual method is used by businesses.  The difference between the two is that with the cash method, you recognize income or expenses when you actually receive or pay them.  With accrual accounting, you recognize income or expense when you earn or are obligated to pay them.

All of that is mostly irrelevant when you're talking about how to track investments.  See the cost basis article I cited earlier for the different ways to handle the accounting of gains and losses in a taxable account.

[oldtoyota]

Got it. Thanks!