ETFs and dividend reinvestment

[tulak]

I'm trying to understand the logistics behind dividend reinvestments with an ETF. If I choose to automatically reinvest the dividend, I'm assuming that I will still have the tax liability on the dividend for the year? Also, part of what I like about ETFs is that there are individual lot's that are easy to track. If I choose to reinvest the dividend, then I'm assuming it would be an additional lot purchase for a small number of shares. Is that correct?

 

[twaddle]

You'll definitely get a tax hit on the dividend whether you choose to reinvest or not.

As to how the reinvested shares are handled, I think the answer is "it depends." If the ETF has a DRiP plan, then the shares are probably held by the transfer company (or issued to you). If you reinvest through your broker, they'll be held in your account and you may or may not get hit with a transaction fee depending on your broker.

In any case, the new shares will have a different basis, and you'll have to account for that if you sell.

 

[LOL!]

I recommend not automatically reinvesting divdends in taxable account, but taking them in cash. That way, you can use the cash for rebalancing. Or you can add a little more cash and buy an integral number of shares. With today's free transactions, it doesn't make as much sense to auto-reinvest either.

 

[tulak]

That's what I was originally thinking: take the dividend in cash and use it for rebalancing. But I wanted to make sure there's no benefit to automatically reinvesting the dividend back into the security. Thanks!

 

[Bikerdude]

I recommend not automatically reinvesting divdends in taxable account, but taking them in cash. That way, you can use the cash for rebalancing. Or you can add a little more cash and buy an integral number of shares. With today's free transactions, it doesn't make as much sense to auto-reinvest either.

I agree. Plus it's a tax nightmare with all the partial share purchases.

 

[Nords]

I agree. Plus it's a tax nightmare with all the partial share purchases.

I think that software (like Quicken) and downloaded transactions has eased the pain of reinvesting dividends. Fidelity does so for free, although admittedly that's a minor savings over making a purchase once or twice a year.

But it raises an interesting question. We know that DCA lags lump-sum investing, although DCA is better for investment discipline. Has anyone seen a study where dividends are allowed to pile up and invested once or twice a year, for example during the current correction? Will lump-sum performance depend on investors being able to identify the correction every year (or so), or could investors just make their annual purchases and not worry about timing the market?

 

[LOL!]

I get dividends every month. I don't hold them, but add them to my monthly investing in assets that need more allocation. Are you suggesting that there are investors that select a single day of the year to "make their annual purchases"? Do you have a secret best day?

 

[Nords]

I get dividends every month. I don't hold them, but add them to my monthly investing in assets that need more allocation. Are you suggesting that there are investors that select a single day of the year to "make their annual purchases"? Do you have a secret best day?

Well, exactly. Reinvesting is painless with financial software and Fidelity's cost-basis tracking, yet perhaps a brainless choice that misses an opportunity like this month's air pockets.

I'm sure that there are investors who've sorted a century of trading data to claim that the "best" day of the year to invest in the S&P500 would be October 14th. Unless... however... of course... except when... but if... and so on.

Everyone's familiar with summer seasonality (especially so this month) and the January effect. Personally we're no longer accumulating but we're not spending every penny of the dividends, either. I could go either way with a "pile up and lump-sum annually" approach or the "brainless reinvesting" approach. I'm just wondering what the researchers have to say.

 

[tulak]

There's never a best day. I believe there are two parts here: when to reinvest the dividend and when to rebalance.

My take is that for reinvesting the dividend, I'll add it to the asset class that is lagging when there's a decent dollar amount. For example, if I only received a $100 dividend, I wouldn't immediately purchase, but once I accumulate $1000, then I'd consider purchasing. At least, that's the idea on this one; I haven't actually done it yet, so I don't know if I'll stick with $1000 or some other value, but I think the overall idea will stay the same.

As for when to rebalance, this is something I will do when my asset allocations are a certain percentage out of whack. For example, if I'm going for 40/40/20 and if it goes to 45/37/18, I'd probably readjust, but if its 42/39/19, then most likely not.

Btw, I'm new to the board, but have been lurking here for awhile. I'm still in the process of tweaking my AA and at this point, figuring out the logistics of maintaining the AA between different accounts.

I've really appreciated the content on the forums so far - it's been a great help in getting things going.