Monday, April 14, 2014

Messages From Readers: An Even Easier, Simpler Way to Invest


Read this if: 

1) You have been investing in stocks or mutual funds. 
2) You’re just curious what “reinvestment” means. 
3) You know what “dividends” and “capital gains” are. If you don’t, read my post here.  



A while ago, I wrote about an investment strategy called “dollar cost averaging,” and later, I explained the difference between dividends and capital gains. This post will explain some more things regarding dividends and capital gain based on a suggestion from a reader. 

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"One painless, almost invisible, way to dollar cost average is to sign up for a dividend reinvestment plan with your stocks or stock mutual funds. When you do this, any dividends you receive on your investment will automatically be used to purchase more shares.

Obviously, this strategy applies only to investment vehicles that pay dividends. Historically, dividends have, I believe, represented about half of the total returns that stock ownership has offered. I believe it is an excellent way for a young person to build a portfolio.

- Larry S. 

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If you have ever opened an investment account and invested in some mutual funds, you’ve probably been asked if you want to “reinvest dividends” or “reinvest capital gains.” I’m gonna explain what that means, and why you should or shouldn’t reinvest. 

Background

It’s important to know that dividends and capital gains are what make your investments worth more money. You should also know that dividends are handed out by the companies you invest in on their terms (sometimes quarterly, or annually, etc.), and that capital gains depend on your investments increasing in share value. 

Where does reinvesting come in?

Instead of taking your dividends and putting all of it in your bank account, you can reinvest dividends by buying more shares with it. Reinvesting capital gains means that a mutual fund company can declare capital gains, which can be reinvested. 

Should I reinvest?

This is a really complicated topic because to most efficiently decide what you should do, you have to take tax rules into consideration. But as the reader stated, reinvesting your dividends is a great way to “build a portfolio,” and I recommend this for every beginning investor. If you read my post on dollar cost averaging, you’ll also know that this is a great way to invest regularly and automatically. (If you haven’t seen that, read this.)

Bottom Line

If you choose to reinvest, know that it is a really simple process. For my Vanguard account, all I had to do was check a little box that said “Reinvest dividends” and another that said “Reinvest capital gains.” 



As always, contact me with questions or suggestions! 

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Photo Credit: Me! 

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