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You need to track your ACB in order to accurately calculate any capital gains or losses when you eventually sell the shares of your ETF. But in my experience, online brokerages are hit and miss when it comes to accurately tracking ACB. So if you want to save yourself the accounting, forget about DRIPs in taxable accounts and just reinvest the cash dividends once or twice a year.
My colleague Justin Bender compared a DRIP to annually reinvesting cash dividends from a Canadian equity ETF and found that over a year period the difference in returns was negligible.
That said, since the accounting is not an issue in RRSPs and TFSAs, dividend reinvestment plans can be an excellent and hassle-free option in tax-sheltered accounts. Your email address will not be published. What you need to know and how those distributions are eventually taxed. Comments Cancel reply Your email address will not be published. Related Articles. Ask MoneySense Is it time to search for bond alternatives for your balanced portfolio?
Understanding why you own bonds in the first place An automatic DRIP is simply a program-offered fund or brokerage firm that allows investors to have their dividends automatically used to purchase additional shares of the issuing security. This practice has been widely used in stock and mutual fund investments, but it is relatively new to ETFs.
Though DRIPs offer greater convenience and a handy way to grow your investments effortlessly, they can present some issues for ETF shareholders because of the variability in different programs. For example, some brokerage firms allow automatic dividend reinvestment but only allow the purchase of full shares. Other firms pool dividends and only reinvest dividends monthly or quarterly. Some reinvest dividends at market opening on the payable date, while others wait until the cash is actually deposited, which is typically later in the day.
Because ETFs trade like stocks and their market prices can fluctuate throughout the day, a reinvestment executed at 7 a. If your brokerage firm does not provide a DRIP option, or if the ETFs in which you are invested do not allow for automatic reinvestment, you can still reinvest dividends manually.
Basically, manual reinvestment means taking the cash earned from a dividend payment and executing an additional trade to buy more shares of the ETF. Depending on where you hold your investment account, you may incur a commission charge for these trades, just like you would with any other trades.
However, some brokerage firms allow for commission-free dividend reinvestments. Manual dividend reinvestment, while less convenient than a DRIP, provides the investor with greater control. Rather than simply paying the market price for new shares on the payment date, you can elect to wait if you feel that the share price may drop.
It also offers the option of holding your dividends in cash if you feel that the ETF is underperforming and you want to invest elsewhere. If you elect to manually reinvest your ETF dividends, be aware of the effect of settlement delays on the buying power of your dividends. Because ETFs, unlike mutual funds, rely on brokerages to keep track of their shareholders, dividend payments typically take longer to settle. Rather than the one-day settlement period of most mutual funds, ETF payments can take two days or more to settle.
If your ETF is doing well, then the additional wait time can mean that you end up paying more per share. Reinvesting your ETF dividends is one of the easiest ways to grow your portfolio, but the structure and trading practices of ETFs means that reinvesting may not be as simple as reinvesting mutual fund dividends.
If you must manually reinvest, keep track of settlement periods to ensure that you do not time your reinvestment poorly. Setting a market order for the moment when your dividend is deposited may not get you the best price per share, so use manual reinvestment to your advantage by actively managing your trades. A few ETFs will pay dividends out as soon as they are received from each stock held in the fund, but the majority collect those dividends and distribute them on a quarterly basis.
Unless you need the cash flows generated from dividends for income, reinvesting those proceeds to buy more ETF shares can compound returns over time and lead to even greater dividend income down the road. The Internal Revenue Service IRS treats dividends that are reinvested the same as if they were received as cash, for tax purposes. As such, they must be reported on your tax returns. Securities and Exchange Commission. Robinhood is one of the most popular brokers, especially among Millenials.
Their intuitive and user-friendly interface makes investing with little cash and no-commission or fees highly appealing. One of the downsides of Robinhood is, however, that their platform sometimes is overly simplified.
Thorough research or analysis is better done elsewhere. When it comes to DRIPs, Robinhood has recently updated their system to make dividend reinvesting a reality. If you choose not to invest your ETF dividends they will generally be paid out in cash and credited to your account.
This will occur four times a year usally each quarter. Vanguard also has the option to have your dividends automatically paid out and transferred to your bank account. This way you can set up a passive income stream from your dividends ETF holdings.
Automatically reinvesting ETF dividends will result in a faster-growing portfolio over time. Not only will your initial capital continue compounding but the dividends received will add to the compounding effect.
Although the difference may not look like much judging by the graphs the numbers tell a different story. This equates to a compound annual growth rate CAGR of 9. Thus, from a portfolio growth perspective, it absolutely makes sense to automatically reinvested ETF dividends.
When it comes to ETF dividends, taxes are always a big issue for every investor. While dividends generally are taxed as regular capital gains you can save some money by declaring them as qualified dividends. Even though DRIPs make it so that you never see the cash in your account from a tax perspective you receive capital gains. Holding ETFs for a longer period of time will allow you to declare those reinvested dividends as qualified which can significantly reduce your tax burden.
If you are looking to avoid paying tax on dividends at all for now. You may consider opening a tax-shielded account such as a Roth IRA. However, once you withdraw money from these type of accounts you will have to pay ordinary income tax which may end up being for then the long-term capital gains tax rate for qualified dividends. Besides putting your money away for the long-term and late retirement, the only option is to make sure to hold your funds for longer than 60 days and pay the lower capital gains rate on your reinvested dividends.
Compared to mutual funds ETFs offer other tax benefits. Although ETFs cannot avoid capital gains completely they can lower the tax burden that is passed on to investors.
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