A cumulative dividend guarantees that you’ll get your dividend payment in the...by Ashley Grasse
Reinvesting Capital Gains: Should You Reinvest or Not?
Capital gain distributions are paid to investors by mutual funds, typically at year’s end, when during the year, the fund has sold holdings that have gone up in price since they were purchased by the fund.
Essentially, the profits from transactions made by the funds are distributed to investors that own the mutual fund.
However, one question everyone faces when they make such a gain is, “should I reinvest capital gains or take them as cash?“
A careful study of the pros and cons of re-investing capital gain payments will help you make an informed decision on this question.
Advantages of Reinvesting Capital Gains
One of the significant advantages of re-investing your capital gains is that the amount available for investment amount increases, and so does the return on it as the reinvested gains form the engine of a growing portfolio.
All that needs to be done is simply instruct your investment manager to automatically re-invest all the capital gain proceeds into your account.
Once done, your earnings, coupled with the initial investment amount, work to earn even higher amounts of dividends and capital gains.
If you choose to re-invest the capital gain payments, there is no commission (also referred to as ‘load’) amount charged by the investment manager.
They generally waive off the sale charges if you include the earnings amount in the investment account.
In terms of tax collected by the Internal Revenue Service (IRS) on both dividend income and capital gains, you can exercise the liberty of delaying tax payments if you re-invest the gain back into your investment account.
Though you will have to pay the tax on capital gains ultimately when you withdraw the cash from your account, re-investing the amount can help you better plan your tax obligations and payments.
Reinvesting Capital Gains From Stocks
You need to analyze if your capital gain is termed as short-term or long-term depending on the holding period (time from acquisition of stock to its disposal).
The IRS has different tax rates for the two categories, with short-term gains taxed at a relatively higher rate.
Disadvantages of Reinvesting Capital Gains
The biggest disadvantage of reinvesting capital gains is that you do not get anything to spend as the profit is simply used to purchase more shares of the fund, compounding your investment amount to benefit you sometime in the future.
It doesn’t reach your bank account and can not be spent on anything else (until you ultimately sell the shares of the mutual fund).
This can be particularly problematic for people who have current obligations to meet and are living off their investments.
Another downside of re-investing the capital gain is the risk you take by re-investing that amount.
So… Should You Reinvest Capital Gains and Dividends?
Nothing is certain, and experiencing the same percentage gain in the future is no exception.
So the decision to cash the gain or compound it for even better gain in the future will depend on the particular fund’s future outlook and market circumstances.
The eventual decision you take when thinking about this decision will depend on the individual.
If the investment has been made for a long-term purpose, then it is probably best to re-invest it.
However, if you are looking for immediate gains, you should take the exit and enjoy the proceeds in your pocket.
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Capital Gains Reinvesting FAQ
Even if you reinvest your capital gains, they are still subject to tax. However, the actual payment of this tax may be deferred until you sell your shares and withdraw the money from your investment account.
Yes, capital gains are generally taxable. The tax rate varies depending on whether the gain is classified as short-term or long-term.
To reinvest capital gains, you generally need to instruct your investment manager or broker to use the gains to purchase more shares in the fund.
Yes, you absolutely can reinvest capital gains. This typically involves purchasing more shares in the mutual fund that produced the gains.
There isn’t a specific timeframe to reinvest capital gains. You can choose to do so immediately after receiving your capital gain distribution.