Reinvest Capital Gains?

[John Galt]

I saw on Vanguard that my current setting is to reinvest capital gains in all of my funds. I didn't even know what this meant, but after a bit of research I figured out this was the decision on what to do with profit from a stock that was sold at a higher price than it was bought.

So my question is, do index funds even have an capital gains? They're not buying and selling stocks, unless they're entering and leaving the index the fund is tracking right? So for example a Total Stock Market index should have no capital gains to redistribute?

Also, for active funds that do trade in and out, what do most bogleheads do, do you reinvest capital gains?

Thanks for the help in advance.

 

[LOL!]

I am still in the accumulation phase.

In my taxable accounts, I do not automatically re-invest distributions. I take them in cash and use them to help with rebalancing. That is, if something that has gone way up pays a distribution, I will use the money to buy shares in a laggard.

In my tax-advantaged accounts, I do automatically re-invest distributions. Since these are mostly bond funds that pay monthly distributions and there are no tax reporting consequences, I think this is the thing to do.

If I was in the decumulation phase, I would probably just use the distributions to pay my expenses.

Distributions could be dividends or capital gains. Tax efficient mutual funds like index funds usually do not pay much in the way of capital gains, but that was not always true. The losses in the stock market in recent years means these funds have built up some internal losses that they can use to offset gains. You can look up the history of the distributions for your fund at the fund's web site.

I saw on Vanguard that my current setting is to reinvest capital gains in all of my funds. I didn't even know what this meant, but after a bit of research I figured out this was the decision on what to do with profit from a stock that was sold at a higher price than it was bought.

Do not confuse a capital gain distribution of which you have no control (the fund just creates it and gives it to you) and a realized capital gain or loss that you create when you sell shares yourself. It is the first (the distribution) that this re-invest question is about.

See also: http://www.bogleheads.org/wiki/Whether_to_Reinvest_Dividends_in_a_Taxable_Account

 

[W2R]

In my taxable accounts, I do not automatically re-invest distributions. I take them in cash and use them to help with rebalancing.

Same here.

I can use the cash from LTCG to beef up whatever fund needs it, according to my asset allocation, later on when I rebalance. Most of my LTCG are from VWIAX Wellesley, an active fund, though there were none in 2009.

I also get my dividends in cash and withdraw them later on for living expenses, since I am in the decumulation phase.

 

[FIRE'd@51]

So my question is, do index funds even have an capital gains? They're not buying and selling stocks, unless they're entering and leaving the index the fund is tracking right? So for example a Total Stock Market index should have no capital gains to redistribute?

This is essentially correct, and the gain is usually the result of a takeover or merger that involves cash. Theoretically, capital gains could be realized if the index fund needed to sell stocks to meet withdrawals which exceeded inflows. Also, a fund which holds index futures collateralized with Treasury bills for liquidity or to reinvest dividends could generate a capital gain as a result of rolling or closing out the futures position, as well as the year-end mark-to-market of the futures. Nevertheless, I believe the last time the Vanguard S&P 500 index fund distributed a capital gain was 1999.