Show #360 Airing Sunday, 10/15/06
Your investments are creating dividends and capital gains distributions. That's great ! It's easy to reinvest these monies right back into that CD or mutual fund if you don't need the cash. But is this decision a smart one? Here to invest us with his knowledge is Jim Lineweaver, founder of the Lineweaver Financial Group.
Question: Many people have savings and investment vehicles where they have the opportunity to reinvest the earnings back into the investment. This could be as simple as leaving the interest on your CDs to accumulate in the CD. What are the advantages and disadvantages of reinvesting the income back into the same investment vehicle? Are there better options than simply reinvesting the income?
Answer; There are two important considerations to take into account in making the right decision. First, are you happy with the performance of the underlying investment vehicle? If you have a CD that has a low rate of return compared to other investments you have, it probably is not a good choice to continue to put additional money into that savings vehicle. If you have a mutual fund that is not performing well, but you just can't get up the nerve to make the decision to sell it, again it probably would be wise to reinvest the mutual fund's dividend and capital gains distributions elsewhere.
Question: That makes good sense-if the underlying investment isn't doing well, why invest more of your hard-earned money in it? Sounds like an easy decision. So what else do we need to consider?
Answer: It makes a difference from a tax standpoint whether the investment is held in a tax-deferred account, like an IRA, or is held in a taxable account.
In a tax-deferred account, receiving the income and then reinvesting it has no tax consequences.
In a taxable account, the income generated is taxed, and at your highest marginal tax bracket. You would be reinvesting the after-tax proceeds.
If you do not need the income for current living expenses, it would be best to try to find a tax-deferred investment so your earnings are not reduced annually. This can increase the total after tax rate of return on the investment quite simply because you are earning additional income on your tax savings. Over time, this impact can be powerful.
What some people do is reinvest the income on their taxable investment, and then withdrawal funds from their tax-deferred accounts to cover their monthly expenses. This makes no sense from a tax standpoint. That is creating taxable income from two investments. Not a good idea.
Question: What would be some better options?
Answer: Look at your financial goals and objectives. Would you provide yourself with better financial security if you had long-term care insurance and had the comfort of knowing that your spouse and your family would be better protected if someone were to go to the nursing home? Have you put off travel plans, like that cruise you have been talking about or that trip to see the grand kids?
If the income from your savings and investments will better help you meet your goals and objectives, you need to re-evaluate whether you should be reinvesting, or investing somewhere else, your dividends, capital gains distributions, and your interest income.
This is all part of the planning process, and the ongoing review, an experienced financial planner can help tailor to your needs.
To reinvest or not reinvest. That is the question. The answer lies in your bigger financial picture. For more information, give Jim a call. The number is next.
