Su­san Hely Rein­vest­ing is not al­ways best

Sim­ply rein­vest­ing dis­tri­bu­tions to ben­e­fit from com­pound­ing may not be the best strat­egy

Money Magazine Australia - - CONTENTS - STORY SU­SAN HELY

Six­teen years ago when I in­vested $10,000 in an Aus­tralian small com­pa­nies fund, I was asked if I wanted to have the div­i­dends and cap­i­tal gains sent to me or have them rein­vested in more units in the fund. I had bought into the fund as a long-term in­vest­ment so I opted for rein­vest­ment. I be­lieved this would be the most fruit­ful way to make my money snow­ball.

But when the fund was wound up re­cently, I won­dered what would have hap­pened if, in­stead of rein­vest­ing the dis­tri­bu­tions in this fund, I had taken them as cash and then in­vested them in the share­mar­ket, for ex­am­ple, via an in­dex-track­ing ex­change traded fund.

My strat­egy of rein­vest­ing in the fund by ac­quir­ing more units left me with a fi­nal re­demp­tion of $31,557. But if I had in­vested the dis­tri­bu­tions out­side the fund, I would have been left with $34,865 based on the S&P/ASX 200. In other words, I would have been around 10% bet­ter off by tak­ing my dis­tri­bu­tions as cash and then buy­ing an in­dex ETF.

This is hy­po­thet­i­cal be­cause small in­vest­ments in ETFs aren’t prac­ti­cal on a con­tin­u­ing ba­sis and I may not have had the dis­ci­pline and en­ergy to di­rectly man­age the in­vest­ment of dis­tri­bu­tions.

But it does raise broader ques­tions about the wis­dom of ca­su­ally rein­vest­ing dis­tri­bu­tions. Does it some­times pay to take your fund man­ager’s cap­i­tal gains and div­i­dends out in­stead of rolling them back into the fund?

What I dis­cov­ered was that my Aus­tralian small com­pa­nies fund was more high risk than I had thought. It was very ac­tively man­aged, with high turnover of as­sets. Some man­aged funds have a less risky strat­egy – for ex­am­ple, an in­dexed share fund spread across the top 200 Aus­tralian com­pa­nies.

While I was hang­ing onto the good re­turns of the early years, this didn’t mean it would con­tinue to per­form well.

My small com­pa­nies fund had a re­volv­ing door of in­vest­ment man­agers, too. It started out as a Port­fo­lio Part­ners fund and when it closed down it was run by a de­scen­dant, Antares.

“You do need to re­view your in­vest­ments,” says Michael Hut­ton, head of wealth man­age­ment at HLB Mann Judd. “We use man­aged funds quite a bit. It’s not a set-and-for­get strat­egy – you do need to be across the port­fo­lio.”

Does he rec­om­mend rein­vest­ing? “Broadly speak­ing it is good to get the cash,” he says. “It gives you the op­por­tu­nity to re­bal­ance the port­fo­lio reg­u­larly.”

For pen­sion­ers who need in­come from their in­vest­ments and have low tax rates, tak­ing out the dis­tri­bu­tions cer­tainly makes sense.

But I was in the ac­cu­mu­la­tion phase, ac­quir­ing wealth for my long re­tire­ment years. Hut­ton says if in­vestors are ac­cu­mu­lat­ing their in­vest­ments, there are ad­van­tages to rein­vest­ing, such as:

• The in­vest­ing hap­pens au­to­mat­i­cally and you don’t have to ac­tively in­vest.

• There are no en­try fees for the rein­vested amounts.

• You are buy­ing ad­di­tional shares at var­i­ous prices in what is called dol­lar cost av­er­ag­ing. You can av­er­age out the price per unit over the long term.

• You are com­pound­ing your in­vest­ment’s growth by adding more shares that will earn div­i­dends of their own over time.

“If you take out the cash, you need to use it to build up your in­vest­ments or else it may be spent,” says Hut­ton. “You need to keep your wealth tick­ing up­wards.”

If you don’t want to add more money to your in­vest­ment, one of the best ways to make sure you keep your div­i­dends specif­i­cally for rein­vest­ments is to put them in a sep­a­rate ac­count so that when the div­i­dends have built up you can use that money to re­bal­ance your port­fo­lio back to your target al­lo­ca­tion at a later date.

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