To Reinvest Or Not To Reinvest

Think that reinvesting your clients’ dividends and capital gains distributions from mutual funds is always the right thing to do?  Think again.  Historically (at least pre-1990), advisors were always taught to reinvest distributions.  These reasons are as follows:

            1.         To avoid paying commissions on the reinvestment of distributions

            2.         To compound the return of the individual mutual fund

            3.         To ensure that the distribution doesn’t get spent by the client

            4.         Convenience for the client

All these reasons came about in an era when investors bought a loaded mutual fund or funds from one mutual fund family, held it forever, put money into it blindly, rarely diversified among asset classes and never rebalanced.  Using discount brokerage accounts eliminates all of these reasons. 

Today, most sophisticated advisors rarely use load funds, have all of their clients’ funds structured within a portfolio utilizing different asset classes spread out across at least several mutual funds from different fund families and have all of their clients’ securities housed at discount brokerage firms.  As a result of these changes, now advisors can, in effect, harvest their gains by not reinvesting mutual fund distributions.  Instead, the distributions are paid into the discount brokerage account’s money market fund where they can then be used to distribute cash to the client if desired, or the advisor can make an active decision to rebalance the portfolio.  This, coupled with the low transaction costs of most trading platforms, prevents or at least minimizes the need for generating additional taxable gains because the advisor would not have to sell off appreciated funds to rebalance and/or generate cash flow for the client.

Reinvesting mutual fund distributions into the same mutual funds for reasons developed in the 1950s, 1960s and 1970s rarely makes sense today.  After all, when you think about it, have you ever seen a mutual fund manager purchase stocks through a Dividend Reinvestment Plan?  The answer is obviously:  no.  Should you?

For further information, contact Louis P. Stanasolovich, CFP ä at (412) 635-9210 or e-mail him at legend@legend-financial.com