Is Reinvesting Mutual Fund Dividends A Good Option?

This post will educate you if reinvesting mutual fund dividends is beneficial or not. But before, you will see some basics in the first few sections.

What are a mutual fund and its types?

To start with, let us see in detail about mutual fund and the two major types.

A mutual fund is a pool of money from individuals as well as organisation. The money is professionally managed to purchase securities. Mutual funds are typically of two types-closed end funds and open end funds.

Closed-End Funds

Through an initial public offering, closed end funds issues a set number of shares to the public. The number of shares is fixed based on the demand and supply. In the open market, these shares are traded. These closed-end funds do not issue new shares and the existing shares will be traded in the exchange. The shares of closed-end funds normally do business at a concession to net asset value.

Open-End Funds

Most of mutual funds are open-ended. This fund does not have a set number of shares. The number of shares varies because they are created and destroyed as necessary. An investor will be issued new shares based on the current net asset value .when the investor decides to sell he can trade the shares. Open-end funds always reproduce the net asset value of the fund’s basic investments.

Based on the principal investments, Mutual funds are also classified stock or equity funds, bond or fixed income funds, money market fund, hybrid funds or other. Index funds which are actively or passively managed funds that match the performance of an index also comes under mutual fund type.

Now you will have a clear idea about mutual funds and its types.

What are the advantages and disadvantages?

Compared to investing directly in individual securities, Mutual funds have its own advantages and disadvantages

Advantages

The fund is invested in diversified securities. The risk is decreased due to diversified investment.

  • The fund holders can sell back the open-end funds and unit investment trusts at regular intervals at a value equal to the net asset value of the fund’s holdings. At the end of every trading day most funds allow investors to cash in this manner.
  • Professional managers are hired to administer the fund’s investments in Open-and closed-end funds.
  • It is a boon to individual investor which helps to participate in investments that may be available only to well-built investors. Investment in foreign market is an example which is often not accessible to individuals.
  • These funds offer excellent Service and convenience.
  • Mutual funds are regulated by a governmental body
  • These funds are required to report the information’s to investors. So there is transparency and makes them easier to compare.

Disadvantages

Mutual funds have disadvantages as well, which include:

  • Fees are imposed on the investor.
  • There is less predictable income.
  • There is no opportunity to customize
  • There is less control over timing of recognition of gains.

Why should you reinvest mutual fund dividends?

There are numerous good reasons to reinvest mutual fund dividends.

When you are investing in a mutual fund with some amount of money, you have to pay some buy-in fee as brokerage. But when you are reinvesting your dividends; you are not paying so many fees.

Your principal will increase as the reinvested dividends acquire more fund shares. When this cycle repeats ,more dividends accumulates over the years, resulting in compound returns. It’s a great way to built wealth on its own.

Reinvesting mutual fund dividends helps to continue during losses in the market. Even in good times as well as bad the reinvestments are made, some amount of dividends will certainly come at times even when the fund value is behind.

Some cases who doesn’t reinvest the dividend

Elders and others who need money from their investments can get the dividends from their mutual funds paid in cash.
A dynamic investor may do better investments elsewhere. So they use the dividends for more good returns.

If you are a diversified investor, then you can cash in your dividend for other investment strategy. Keeping money in same fund might be too risky sometimes .Let us see some tax implications on reinvesting your dividend.

Tax implications

In case of non-retirement accounts, capital gain tax will be imposed for dividends from mutual funds whether you reinvest or take out as cash. Consult your tax consultant for best results and keep good records .Some tax free funds like municipal bond funds might help you.

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