Why we never automatically reinvest dividends

Over the last week, FZ Members received their quarterly dividends.

Dividends can either be automatically invested back into the fund that paid them OR they can get paid out in cash.

We always, always, always have them paid out in cash.

Here’s why…

Imagine a world where there are no dividends (or bond income).

Let’s say you own a 50/50 stock/bond portfolio.

Stocks have a good year (let’s pretend), so now your portfolio is 60/40 stocks to bonds.

To rebalance and get it back to 50/50, you’d have to sell stocks to buy more bonds.

That would likely incur capital gains tax because you made money in stocks.

The benefit of rebalancing is worth the cost of the tax, but wouldn’t it be nice if there was a way around it?

And thanks to dividends (and bond income), there is!

When dividends and bond income are paid, we use it to buy more of the thing we need to buy more of.

So in our example, when the dividends are paid, we use that cash to buy more bonds.

This allows us to rebalance WITHOUT selling anything which means no capital gains tax.

So check all of your accounts to see if you have the lever pulled to automatically reinvest dividends.

If you do, consider turning it off and executing the Financial Zen strategy.

(And if you’re an FZ Member, you don’t need to check a thing. We’ve already gotchu.)