I do my own taxes partly to save money and, more importantly, for the chance to soberly review every transaction I made during the year. I have noticed something interesting that doesn't seem to be talked about much concerning the reinvestment of dividends.
To me reinvesting dividends only makes sense if the trading price of a stock at the time of the dividend is considerably less than its intrinsic value; that is, if reinvested dividends will be purchasing shares at a good price. If that's the case, why would I want to increase my holdings in a company the amount of a small dividend? If the stock is that much of a bargain, I'd rather pile in with new money.
If the price of a stock has risen to its intrinsic value or considerably above, why would I purchase more shares through a dividend if I wouldn't buy the shares with new money? In other words, why would I overpay for a stock through dividends just because I'm using "free" money?
Isn't it better to use dividends for better, newer ideas instead of potentially overpaying for old ideas?
Here's another aspect of reinvesting dividends that has irked me. Through my own folly I have bought stock, seen the prices rise, reinvested dividends, and then sold all the shares later for a loss, including shares bought with reinvested dividends. Shame on me for losing my capital through my own foolishness, double shame on me for paying too much for shares with reinvested dividends, and triple shame on me for losing my portion of the company's earnings through poor buying and selling decisions.
I would have been better served to have bought the shares I wanted, KEPT (!!) the profits of the company that were due me, used that money wisely, and also to have chosen a different stock!
Here's one more wrinkle: At the time of sale, shares that were purchased through dividend reinvestment in the last year of ownership will be taxed at the higher short term rate whereas older shares will be taxed at the lower long term capital gains rate. It could be a better use of your dividends to invest them in another long term investment. And it makes doing your taxes by hand a great deal easier.
I have learned these principles through the courses of hard knocks and I believe they are sound. Your thoughts?
I also resolve to do a better job of picking stocks :)