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samclem 12-07-2013 08:40 PM

Rethinking Where To Hold Dividends And Interest As They Are Earned
 
Like many people, I have the periodic dividends and interest payments from my taxable accounts going into a money market fund rather than to purchase additional shares of the fund. This makes it easy at the end of the year to use these funds (for rebalancing, or spending) without needing to sell shares of the fund (and generate a possible cap gain to be taxed).
It occurs to me that this is no longer necessary or desirable. With the new basis reporting rules and the very easy tracking of "lots" on Vanguard's site (probably the same at other companies), I have gone from using "average cost" basis to using "specific shares" basis. While it used to be expensive for me to sell shares recently purchased with dividends (because I used "average basis", which was fairly low), I can now sell these appreciated shares relatively cheaply if they haven't gone up much in price. And, if prices have dropped, these newly purchased shares might offer a handy opportunity to harvest some losses for tax purposes, if a person is paying taxes on ca gains.

All this is probably fairly obvious, but changing the handling of my periodic dividend and interest payments in light of the new basis reporting rules wasn't something that had occurred to me before.

karluk 12-07-2013 09:47 PM

Over the years I have used both reinvestment and transfer to money market for my dividends. They both have good points, so which one you chose is largely a matter of individual circumstances and personal preference.

If you rely on dividends as part of your retirement income, I would avoid reinvesting your dividends. In my experience it's just a matter of time until you find yourself needing to sell some shares a few weeks after your dividends were reinvested, and end up running afoul of the wash sale rules. That can be a significant problem with automatic reinvestment - it happens when you probably aren't paying close attention and don't think through the effect it will have on your short term finances.

If selling shares to raise cash is likely to be a rare event for you, I would probably go ahead and reinvest dividends. It's aggravating during rising markets to see cash sitting in a money market that could just as well have been reinvested and be working for you.

scrabbler1 12-08-2013 11:36 AM

As an early retiree, I use the dividends from my various investments to cover my expenses. With most of the dividends coming from one "big" bond fund, I take those as cash into my local bank's checking account to pay the bills. If I have any surplus from those dividends (and I plan it out over many months because some months have more expenses than others), I buy some extra shares from that same bond fund.

This bond fund sometimes makes cap gains distributions (like it just did over this passed weekend). These are irregular in amount and occur only twice a year, so I have those set to automatic reinvestment, adding to the number of shares I own which subequently gives me a slightly bigger monthly dividend.

I have other funds, some stock and some bond, which make monthly and less frequent distributions (dividend and cap gains). I reinvest all of them although at times I used one or more of them as "automatic account builders" for the big bond fund, a tactic I have used often over the years even before I retired.

I never want to have a big blob of money sitting in an account earning next to nothing for an extended time. A few months is fine if it is assigned to pay for a large, irregular expense. But nothing longer than that.

jerome len 12-08-2013 01:42 PM

I reinvest my mutual fund dividends because I don't need them for living expenses. I also don't mind paying taxes in the current year since I believe taxes will be higher in future years. Someday when I need dividends for living expenses I'll take them in cash and move the funds to my cash living expenses account as they are paid.

Eveyone has their own plan. Right now I can live off of SS and bond interest checks allowing my stocks and stock dividends to grow and cover inflation in the future.

samclem 12-08-2013 02:05 PM

Quote:

Originally Posted by scrabbler1 (Post 1388551)
This bond fund sometimes makes cap gains distributions (like it just did over this passed weekend). These are irregular in amount and occur only twice a year, so I have those set to automatic reinvestment

And there's no right answer for everyone, but a good thing about your approach is that you'll constantly be buying shares at the "new" prices. That means presumably that they'll be well positioned for use in harvesting a loss if the share price of this bond fund falls anytime between when you receive the distribution and the end of the year (assuming the person is using the "specific shares" method, which is now very easy, and that is in a taxable account).

For people who are in the withdrawal phase, these new purchases may represent the only "high basis" shares in their taxable accounts, and a good opportunity to tailor taxable income (to qualify for for PPACA subsidies, etc).

RunningBum 12-08-2013 02:46 PM

OK, I finally get your point. If you have room for more income in a certain year, you could sell funds that have a lower basis. If you have less room, you sell from the highest basis, which may very well be what you just invested. You would take a short-term capital gain from those shares, but that's ok, it means you made something rather than just parking it and getting virtually nothing.

I may reconsider, though right now I'm using any extra room for Roth conversions, rather than taking it in more cap gains.

Still, it means I can sell whichever shares I want when I need it, rather than taking cash just because the distribution came. Of course I could just manually reinvest, just losing the few days in the market before I notice the new money and the transaction time. I think Vanguard will help me track wash sales, so I don't consider that a "must-avoid". On the other hand, I've been using it as a kind of automatic withdrawal, to avoid trying to time the market, which I rarely seem to get right.

I'll have to stew on this for a day or two and decide whether to change before the year end distributions.


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