Author Topic: Forbes: "Reinvesting is a bad idea"  (Read 8020 times)

nereo

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Forbes: "Reinvesting is a bad idea"
« on: October 16, 2015, 11:14:16 AM »
when reading through some stuff on tax implications for selling off mutual funds I came across this juicy nugget on the Forbes site.

4. Reinvesting is a bad idea. You put $100,000 in a fund, it makes a $5,000 distribution, and you use that to buy more fund shares. That sounds nice, except that it messes up your cost basis. You now have two lots of shares with two purchase prices and two holding periods. Keep this up for a decade and you could wind up with 10 or 40 or even 120 purchases. Now what happens when you want to take some money out? That means selling shares. Which shares are you selling? Bought at what prices?

The only way to cope with this mess is to use the fund company’s “average cost” calculation when you sell shares. That’s suboptimal. It would be better to identify the high-cost shares as the ones you’re selling.

A better idea is to check “No” when asked about whether to reinvest. Send distributions (both income and capital gain distributions) into your money market account. When that account gets fat, use it to make a lump-sum purchase of the same or a different fund. When you want to need to raise cash, you can pick a high-cost position to minimize your tax burden.


whaaaa....?  Reinvesting my dividends has always been a core tenant of my 'lazy-man's' strategy for garnering wealth.  I get that later on (decades later) it may be slightly sub-optimal for tax purposes, but since my gains are all LT capitol gains I seriously suspect that shuttling it into a MMA and waiting "until it gets fat" would be too big of a cash drag to make up for any tax-loss harvesting I would otherwise get by dutifully tracking each dividend and share purchased over a decade+.
Or am I wrong? 

FIRE47

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #1 on: October 16, 2015, 11:37:11 AM »
This is a load of crap, its pretty simple math and for identical shares they all have the same cost base, that being the average cost. (The total cost to purchase all of the shares divided by the total number of shares). There are no high cost and low cost shares.

You can't skirt the rules and use a higher cost when you sell simply by making a separate purchase of the same fund or shares rather than reinvesting automatically.... This is from a Canadian perspective but it almost seems so much like commons sense there's no way you can abuse the system this way in the US.

The only thing is yes, you have to track the cost base over all those years - which means tracking the cost of each automatic reinvestment - for most people this means hiring an accountant to sort it out 30 years later when old uncle Bob croaks and has been reinvesting the dividends all those years.

KCM5

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #2 on: October 16, 2015, 11:41:14 AM »
One only needs to care about this if it's in a taxable account, right?

FIRE47

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #3 on: October 16, 2015, 11:44:05 AM »
One only needs to care about this if it's in a taxable account, right?

Yes but don't be fooled by this shoddy piece - just keep track of the amount of each reinvestment (for most of us this is a couple distributions a year per fund).

MDM

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #4 on: October 16, 2015, 11:44:35 AM »
4. Reinvesting is a bad idea. You put $100,000 in a fund, it makes a $5,000 distribution, and you use that to buy more fund shares. That sounds nice, except that it messes up your cost basis. You now have two lots of shares with two purchase prices and two holding periods. Keep this up for a decade and you could wind up with 10 or 40 or even 120 purchases. Now what happens when you want to take some money out? That means selling shares. Which shares are you selling? Bought at what prices?

The only way to cope with this mess is to use the fund company’s “average cost” calculation when you sell shares. That’s suboptimal. It would be better to identify the high-cost shares as the ones you’re selling.

A better idea is to check “No” when asked about whether to reinvest. Send distributions (both income and capital gain distributions) into your money market account. When that account gets fat, use it to make a lump-sum purchase of the same or a different fund. When you want to need to raise cash, you can pick a high-cost position to minimize your tax burden.

Was that Forbes article from the 1950s?  Today we have things called computers with programs like Quicken that can track the basis of each lot quite easily.  Also, for any mutual fund shares purchased (including via dividend reinvestment) after 2011, the brokerage is required to track the basis and report that to you and the IRS for any sales.

There is no requirement for you to use average cost.  That may, however, be the default so you may need to select "use individual lots" as your basis when you sell.  E.g., see http://individual.troweprice.com/public/Retail/Products-&-Services/Brokerage/Wide-Reaching-Benefits/Common-Cost-Basis-Questions, or the equivalent at the broker where you hold shares.

Proud Foot

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #5 on: October 16, 2015, 11:45:20 AM »
One only needs to care about this if it's in a taxable account, right?

Exactly! The only time you would need to keep track would be in a taxable account.  But if you're holding for the long term the average cost works just as well since all you would only have long term capital gains.

nereo

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #6 on: October 16, 2015, 11:51:15 AM »
One only needs to care about this if it's in a taxable account, right?
Yeah, the article began with "this is for taxable accounts only".
Later on it does mention that index funds are particularly tax efficient - I just have some leftover mutual funds from the 90s that I'm now investing in a better place.

nereo

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #7 on: October 16, 2015, 11:54:16 AM »

Was that Forbes article from the 1950s?  Today we have things called computers with programs like Quicken that can track the basis of each lot quite easily.  Also, for any mutual fund shares purchased (including via dividend reinvestment) after 2011, the brokerage is required to track the basis and report that to you and the IRS for any sales.
...
Ok, thank you MDM - this is exactly what I was thinking.  With every trade now logged on a computer it almost seems idiotic that there wouldn't be an automatic way of tracking each share that was purchased (including dividends).
In my formative years I never keep track of such things, and the funds don't seem to offer statements going back more than a couple of years.

FIRE47

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #8 on: October 16, 2015, 11:54:21 AM »
One only needs to care about this if it's in a taxable account, right?
Yeah, the article began with "this is for taxable accounts only".
Later on it does mention that index funds are particularly tax efficient - I just have some leftover mutual funds from the 90s that I'm now investing in a better place.

So hold on, in the US you have to track even identical units and shares by "lot"? Sounds aweful, although it leaves more room for planning, for most people that just sounds like a disaster 20 years in the making trying to figure that out.

Tyler

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #9 on: October 16, 2015, 11:54:44 AM »
Quote
The only way to cope with this mess is to use the fund company’s “average cost” calculation when you sell shares. That’s suboptimal. It would be better to identify the high-cost shares as the ones you’re selling.
Was that Forbes article from the 1950s?  Today we have things called computers with programs like Quicken that can track the basis of each lot quite easily.  Also, for any mutual fund shares purchased (including via dividend reinvestment) after 2011, the brokerage is required to track the basis and report that to you and the IRS for any sales.

+1 

The Forbes article is factually incorrect.  Brokerages automatically track cost basis for all individual shares, (although depending on the brokerage you may need to change it from the default "average" setting).  I've sold specific individual lots from Fidelity, and it's very simple. 

MDM

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #10 on: October 16, 2015, 12:01:22 PM »
So hold on, in the US you have to track even identical units and shares by "lot"?
It's not "have to", it's "are allowed to".

In other words, you are forced to use average cost (and thus give up any savings that use of individual lots would afford) if you weren't diligent about tracking your pre-2011 lot basis.

LAGuy

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #11 on: October 16, 2015, 12:07:01 PM »
Well, there is one other really good reason to not automatically reinvest dividends. It's to avoid the "wash rule" when tax loss harvesting. That is, if you sell something for tax reasons you're then not allowed to buy back that exact same fund within 30 days or the IRS will consider it a wash sale and you won't be able to realize the tax implications. If you've got an automatic dividend reinvestment, it might kick in at an inopportune time.

MDM

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #12 on: October 16, 2015, 12:27:24 PM »
Well, there is one other really good reason to not automatically reinvest dividends. It's to avoid the "wash rule" when tax loss harvesting. That is, if you sell something for tax reasons you're then not allowed to buy back that exact same fund within 30 days or the IRS will consider it a wash sale and you won't be able to realize the tax implications. If you've got an automatic dividend reinvestment, it might kick in at an inopportune time.
Good point to remember.  Although, if the amount of dividend reinvestment is minimal compared with the amount you sell, the tax implications are minimal as well.  The wash rule applies only to the amount purchased, not to the total amount sold.

Gone Fishing

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #13 on: October 16, 2015, 12:47:04 PM »
Well, there is one other really good reason to not automatically reinvest dividends. It's to avoid the "wash rule" when tax loss harvesting. That is, if you sell something for tax reasons you're then not allowed to buy back that exact same fund within 30 days or the IRS will consider it a wash sale and you won't be able to realize the tax implications. If you've got an automatic dividend reinvestment, it might kick in at an inopportune time.
Good point to remember.  Although, if the amount of dividend reinvestment is minimal compared with the amount you sell, the tax implications are minimal as well.  The wash rule applies only to the amount purchased, not to the total amount sold.

Agreed. Even if you flubbed it on your returns, I'm pretty sure it would take an audit to uncover a wash sale. However, I did recently diverted some dividends to another fund for this exact reason.

Another related question, after a sale, will Vanguard allow dividend reinvestment on a fund with a frequent trading policy that prevents reinvestment within xx days of a sale if you are still in the "blackout" period?

NoraLenderbee

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #14 on: October 16, 2015, 02:19:00 PM »
4. Reinvesting is a bad idea. You put $100,000 in a fund, it makes a $5,000 distribution, and you use that to buy more fund shares. That sounds nice, except that it messes up your cost basis. You now have two lots of shares with two purchase prices and two holding periods. Keep this up for a decade and you could wind up with 10 or 40 or even 120 purchases. Now what happens when you want to take some money out? That means selling shares. Which shares are you selling? Bought at what prices?


Was that Forbes article from the 1950s?  Today we have things called computers with programs like Quicken that can track the basis of each lot quite easily.  Also, for any mutual fund shares purchased (including via dividend reinvestment) after 2011, the brokerage is required to track the basis and report that to you and the IRS for any sales.


Haha, exactly. What's next--"Don't make extra principal payments on your mortgage, because you'll have to recalculate the amortization table by hand, and that's impossible!!"?

Beaker

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #15 on: October 16, 2015, 02:34:54 PM »
Was that Forbes article from the 1950s?  Today we have things called computers with programs like Quicken that can track the basis of each lot quite easily.  Also, for any mutual fund shares purchased (including via dividend reinvestment) after 2011, the brokerage is required to track the basis and report that to you and the IRS for any sales.

Does that apply for individual stocks as well?

Personally, I'm still hesitant about automatic reinvestments (perhaps irrationally) after I got bitten by it. But that was individual stocks purchased 2004-2007 and  then moved to a different brokerage. By the time I sold them the brokerage had no idea what the cost basis was, and neither did I.

In any case, you might also want to avoid automatic reinvestments because manually allocating the cash is a way to keep your allocation in the desired range.

MDM

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #16 on: October 16, 2015, 02:36:42 PM »
"Don't make extra principal payments on your mortgage, because you'll have to recalculate the amortization table by hand, and that's impossible!!"?
The horror! The horror! :)

MDM

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #17 on: October 16, 2015, 02:41:05 PM »
Does that apply for individual stocks as well?
Individual stocks have been covered since 2011, mutual funds since after 2011.  See https://ttlc.intuit.com/questions/2101431-difference-between-covered-and-non-covered-basis-when-reported-and-non-reported-to-irs-regarding-capital-gains-and-capital-loss.

Quote
Personally, I'm still hesitant about automatic reinvestments (perhaps irrationally) after I got bitten by it. But that was individual stocks purchased 2004-2007 and  then moved to a different brokerage. By the time I sold them the brokerage had no idea what the cost basis was, and neither did I.
Things have indeed changed since then.  Might be worth revisiting.

Quote
In any case, you might also want to avoid automatic reinvestments because manually allocating the cash is a way to keep your allocation in the desired range.
That is also a defensible strategy.  No one size fits all.

ShoulderThingThatGoesUp

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #18 on: October 17, 2015, 06:07:50 AM »
Schwab has a list of every portion of my cost basis for every stock I've held, no matter how long that's been. An execrably stupid article.

Davids

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #19 on: October 17, 2015, 05:10:46 PM »
I heard of this invention called a computer that can do the work for you.

reddityeah

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #20 on: October 18, 2015, 04:52:33 PM »
is there somewhere in vanguard that shows every portion of my cost basis? all i see is the average cost basis

Kaspian

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #21 on: October 19, 2015, 01:32:38 PM »

A better idea is to check “No” when asked about whether to reinvest. Send distributions (both income and capital gain distributions) into your money market account. When that account gets fat, use it to make a lump-sum purchase of the same or a different fund. When you want to need to raise cash, you can pick a high-cost position to minimize your tax burden.[/i]


Seems pretty crazy and a whole lotta work to leave a giant chunk of change sitting there doing nothing for periods, doing big lump-sum purchases (which encourages timing), all to save a couple hundred bucks (at most) on taxes.  What about the lost opportunity cost if the markets flew up when dividend distributions would have happened as opposed to the lump purchase?    These types of articles really encourage "paralysis by analysis" and discourage regular investors by making things sound complicated.  Yeah, use the tax shelters as much as you can, but when people start going on about taxes versus investments they're often putting the cart before the horse.

rockstache

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #22 on: October 19, 2015, 01:56:28 PM »
I just started my first taxable account this year and all of it is in VTSAX. Won't I get an end of year statement showing the dividends reinvested be tracked for tax purposes? I was kind of counting on that, otherwise I am not really sure what I am supposed to be doing. I do my own taxes (Dinks filing jointly, no house or business), and they are fairly simple, but I was worried about the implications with the taxable account.

MDM

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #23 on: October 19, 2015, 02:14:02 PM »
I just started my first taxable account this year and all of it is in VTSAX. Won't I get an end of year statement showing the dividends reinvested be tracked for tax purposes? I was kind of counting on that, otherwise I am not really sure what I am supposed to be doing. I do my own taxes (Dinks filing jointly, no house or business), and they are fairly simple, but I was worried about the implications with the taxable account.

You should be fine.  Dig deep enough in Vanguard's online information about your account and you'll find the text below:
Quote
Vanguard will report cost basis information to the IRS only for "covered shares," meaning those acquired and subsequently sold after cost basis reporting requirements take effect.

For "noncovered shares"—those acquired before the respective effective dates of cost basis reporting regulations, or acquired in an account not subject to IRS Form 1099-B reporting (such as IRAs or C-corporation accounts)—Vanguard will report cost basis information only to you.
Holding type                          Covered shares                                                                                               Noncovered shares
Stocks and certain ETFs *        Shares acquired on or after January 1, 2011, and subsequently sold.                     Shares acquired before January 1, 2011, and subsequently sold.
Mutual funds ** and ETFs       Shares acquired on or after January 1, 2012, and subsequently sold.                    Shares acquired before January 1, 2012, and subsequently sold.
Bonds and options                 Bonds or contracts acquired on or after January 1, 2014, and subsequently sold.     Bonds or contracts acquired before January 1, 2014, and subsequently sold.

* ETFs that are unit investment trusts (UITs) and are taxed as regulated investment companies. If you're not sure whether this applies to your ETF, check with your issuer.

** Excluding money market funds.

You remain responsible for reporting your cost basis information on Form 1040, Schedule D, for all shares sold, whether they're covered or noncovered. You can use your own records or the cost basis information Vanguard provides you. For your covered shares, it's important that the information you report matches what Vanguard reports to the IRS on Form 1099-B.

Those who have Employee Stock Purchase Plans, however, should double check their 1099s.  See http://forum.mrmoneymustache.com/investor-alley/your-2014-1099-b-form-for-an-espp-sale-will-probably-be-wrong/.

NoraLenderbee

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #24 on: October 19, 2015, 05:18:03 PM »
I just started my first taxable account this year and all of it is in VTSAX. Won't I get an end of year statement showing the dividends reinvested be tracked for tax purposes? I was kind of counting on that, otherwise I am not really sure what I am supposed to be doing. I do my own taxes (Dinks filing jointly, no house or business), and they are fairly simple, but I was worried about the implications with the taxable account.

Yes. Vanguard will send you a 1099 form that shows all the income and gains the fund generated this year.

Tjat

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Re: Forbes: "Reinvesting is a bad idea"
« Reply #25 on: October 19, 2015, 06:22:17 PM »
Even ignoring all the above, is forbes really trying to argue that the "suboptimal" effect of average cost basis IS MORE than taking all distributions and parking in a money market account until it gets "Fat enough" @ 0% interest?

In a taxable account, why would you even worry about distributions? Your investments shouldnt generate many that are non-qualified, unless you're doing it wrong.