Mutual fund distributions - turn off reinvestment ?

[Delawaredave]

Lots of managed funds are going to have sizable distributions in December. Below is link from Vanguard, for example.

Used to have distributions reinvest in same fund. Given:
- Large distributions in December,
- I'm moving (gradually) to indices / ETFs, and
- Need to rebalance down in equities a bit,

I'm planning to redirect distributons of active funds to cash/money market.

Seems like a good idea to me. Appreciate any thoughts.

http://tinyurl.com/yjdu72

 

[mickeyd]

I'm planning to redirect distributons of active funds to cash/money market.

I have recently taken the same action with my Vanguard accounts that are taxable.

 

[samclem]

I have all my distributions from taxable accounts going into a MM fund, then once each year I rebalance into the asset classes I'm short on. Since I'll already be paying taxes on it, it is a good way to try to address imbalances without additional tax costs.

I think this is a fairly common practice.

 

[magellan_nh]

I turned off reinvestment on all our taxable funds and it's been working out great for both rebalancing and for providing cash flow.

Another thing that the upcoming distributions are getting me to think about is starting rebalancing early for international funds (particulary european). If I wait for the distribution, a bunch of it will be dividends which are non-qualified and therefore not taxed at the reduced rate and which are subject to state taxes.

Since the Vanguard European Index fund is up around 30% this year, I have to sell a bunch to accomplish rebalancing (around 30% of holdings). Also, since I plan to do a roth conversion next year, moving the income into this year won't be a bad thing either.

I'll need to keep the funds out of the market for a week or two to avoid "buying the distribution" on the way back in (probably going to pac rim and to growth index), so there's a bit of a risk there.

Can anyone think of anything else that I'm missing?

Jim

 

[ERD50]

I have all my distributions from taxable accounts going into a MM fund,...

Same here. It makes several things a bit easier. As stated, you can rebalance (or spend) as needed. And you won't need to change a thing from the years you want to spend vs the years you want to reinvest/rebalance.

It can also avoid a few extra lines on your taxes. Most funds provide the info, but you still need to enter it. Those withdrawals can actually create a wash sale - to me, it is just not worth any additional hassle at all. KISS - all distributions to a MM fund.

-ERD50

 

[TromboneAl]

Sorry I'm being dense here, and not understanding. Can someone spell out the advantages of this including an example? Thanks.

 

[mickeyd]

Can someone spell out the advantages of this including an example?

One advantage that I see is that if you wish to sell specific shares of a MF that is taxable (sell shares that have highest acquisition costs=less tax). Otherwise you have to use the average cost of acquisition as your basis. It appears to me that you can manage to avoid income tax by selling shares that have the highest cost basis. If you have a number of dividend/CG purchases along the way (each qy) it just clutters up the landscape and makes the process of selecting which specific shares to sell a bit more labor intensive.

If you were going to sell 100% of the shares in the MF in a single tax year, I do not think that it would make any difference.

 

[free4now]

I'm too lazy too give a detailed example, but the point is this: when a distribution occurs, that is a taxable event which results in some amount of cash going somewhere. If you have it set to autoreinvest, then that cash can only go one place, but if you have the dividends go into a money market fund then you can access that cash for any purpose you need it, without the transaction cost and tax accounting hassles of selling shares.

In general it seems that while one is in accumulation phase, automatic reinvestment can make sense because there is cash flowing in that can be used for rebalancing or whatever. But when you are in retirement and there is no cash flowing in, taking advantage of the dividends by turning off reinvestment makes sense.

Thanks for this thread... as a newly FIREd person this was a good reminder that I need to look into turning off autorinvest.

 

[audreyh1]

I'm planning to redirect distributons of active funds to cash/money market.

Seems like a good idea to me. Appreciate any thoughts.

Yes, that's one way I manage rebalancing in my taxable accounts.

Funds that are under allocation - I reinvest those distributions. I don't want these funds shrinking any further!
Funds that are over allocation - I redirect distributions to cash.

Another thing to consider is paying taxes. Since you will owe taxes on the distributions (in your taxable accounts) you want enough of the distributions going to cash to pay your taxes.

 

[TromboneAl]

Another thing to consider is paying taxes. Since you will owe taxes on the distributions (in your taxable accounts) you want enough of the distributions going to cash to pay your taxes.

Is that an issue very often?

My understanding so far:

1. It's a convenient way of rebalancing
2. It's more convenient than actually performing a sell explicitly.
3. You won't pay any more in taxes, but you won't have to sell shares to pay them
4. You're taking money out anyway, so may as well have it happen automatically

I'd rather do my rebalancing once a year. Don't studies show that more frequent rebalancing is less effective?

If you send the distributions to MMF, then you're essentially selling a lot of stock in early December. No Santa Claus rally for you (not that I'm a market timer)!

 

[Nords]

One advantage that I see is that if you wish to sell specific shares of a MF that is taxable (sell shares that have highest acquisition costs=less tax). Otherwise you have to use the average cost of acquisition as your basis. It appears to me that you can manage to avoid income tax by selling shares that have the highest cost basis. If you have a number of dividend/CG purchases along the way (each qy) it just clutters up the landscape and makes the process of selecting which specific shares to sell a bit more labor intensive.

All our funds reinvest dividends, with the exception of Tweedy, Browne which we're slowly liquidating. Reinvesting seems to be an autopilot way of keeping the money at work instead of casting about for a new place to put it. But we're still in the process of shifting/simplifying our asset allocation and we could raise our rebalancing cash by cleaning up the leftovers. Maybe when we arrive at our ultimate asset allocation we'll stop reinvesting dividends and let the distributions replenish the cash stash. But if we're not spending the cash then I'd hate to let it keep piling up in the MM waiting for a stock market's *****-like return to reasonable valuations.

One advantage to reinvesting stock/ETF dividends is that the brokerage may do it for free... instead of for that horribly costly $8 commission. Admittedly not much of an advantage.

As for selling specific shares, Quicken handles that job beautifully. We'd been DCA'ing and reinvesting shares in Tweedy's Global Value fund for over six years before we stopped. Today when we sell specific shares we click on the Quicken buttons to "select specific shares" and "minimize capital gains". We can even tweak the share sales to a certain amount of cap gains. Fidelity's trading software will also let you look at specific stock/ETF share lots and sell the ones that've generated the most/least cap gains.

 

[samclem]

I'd rather do my rebalancing once a year. Don't studies show that more frequent rebalancing is less effective?

If you send the distributions to MMF, then you're essentially selling a lot of stock in early December. No Santa Claus rally for you (not that I'm a market timer)!

Actually, you aren't selling anything if you have the proceeds dumped into a MM fund. You are avoiding the automatic purchase of more shares of the funds which are making the distribution. Then, with all the funds that have been dumped into the MM fund, you can do the things that you'd otherwise have to sell shares to do (pay taxes, buy shares in underfunded asset classes, etc). You avoid the need to possibly sell shares (and therefore pay the taxes you'd owe) by doing things this way.

Yes, rebalancing more frequently does reduce returns compared to doing it less frequently. But, rebalancing more frequenty reduces the overall volotailty of your portfolio. It's similar to the situation with owning more equities vs owning CDs. Owning stocks will likely produce higher returns over many years, but the ride can be "breathtaking."

 

[Red-y]

One other consideration is redemption fees, e.g. the Vanguard Tax Managed funds have a nasty 1% redemption fee on any shares held less than 5 YEARS. If you've got anything in those funds that you're planning to liquidate for living expenses in 2011, you can turn off reinvesting the dividends now so you don't get stung by the redemption fee.

 

[d]

that's one way I manage rebalancing in my taxable accounts.

i'm with audrey!

 

[FinanceDude]

Interesting thread.........I have a friend who is a CFP, and he manages his taxable accounts that way. When people are accumulating, he reinvests. When they are closer to retirement, or retired, and drawing income, he stops reinvesting. The benefits according to him are:

1)Cost basis is easier to manage, and you have a better idea of how the manager is doing.

2)You're taking the dividends and shares out, and you need income anyway.

He does watch the tax tables to make sure he's not increasing their tax rate........

 

[audreyh1]

Is that an issue very often?

Al - that's an issue for me simply because I don't send ALL my distributions to cash, I reinvest distributions on some funds (the underperforming asset classes). So I gotta make sure that I take enough distributions to cash to cover taxes AND rebalancing where possible.

Audrey

 

[samclem]

He does watch the tax tables to make sure he's not increasing their tax rate........

FD,
I'm not clear on this. How could it increase their tax rate? If the MF is in a taxable account and makes a distribution, then the owner will be taxed on it whether or not it is re-invested, right?

 

[FinanceDude]

FD,
I'm not clear on this. How could it increase their tax rate? If the MF is in a taxable account and makes a distribution, then the owner will be taxed on it whether or not it is re-invested, right?

It is a taxable event either way.......I guess I need to clarify what he meant by that.........perhaps he meant to say something else........

 

[ESRBob]

Here's what he might mean -- If there are lots of distributions and some other sales etc that year, along with interest income etc, the client/investor could be realizing enough income to be in a higher tax bracket. Although you wouldn't be able to do anything about these distributions, (except sell fund shares before the distributions occur perhaps?) you could watch them and thus not make any other voluntary sales that would trigger taxes. Too much work for me!

I have nearly all my taxable funds' dividends flow into MM and count on that 2% or so a year for the first half of my annual safe withdrawal for spending money. THen I only need to sell another 2% or so of appreciated assets. During my annual rebalancing I put an extra 2% into the Cash/MM asset class and rebalance with that in the weighting, then, hey presto, it all works out really smoothly.

If anyone wants, PM me with and I can send you a spreadsheet I use to do all that rebalancing stuff semi-automatically.

 

[FinanceDude]

Here's what he might mean -- If there are lots of distributions and some other sales etc that year, along with interest income etc, the client/investor could be realizing enough income to be in a higher tax bracket. Although you wouldn't be able to do anything about these distributions, (except sell fund shares before the distributions occur perhaps?) you could watch them and thus not make any other voluntary sales that would trigger taxes. Too much work for me!

I have nearly all my taxable funds' dividends flow into MM and count on that 2% or so a year for the first half of my annual safe withdrawal for spending money. THen I only need to sell another 2% or so of appreciated assets. During my annual rebalancing I put an extra 2% into the Cash/MM asset class and rebalance with that in the weighting, then, hey presto, it all works out really smoothly.

If anyone wants, PM me with and I can send you a spreadsheet I use to do all that rebalancing stuff semi-automatically.

That's what he was referring to.........I talked to him yesterday........