Man investing in front of laptopIn most corporate retirement accounts (i.e. 401k(s)) your company and the plan administrator limit your investment choices.  In these instances it is common for mutual funds, and more recently exchange traded funds (ETFs), to make up the investment universe.  While limitations of any kind can be frustrating, mutual funds have a unique option that can be a very useful tool, dividend reinvestments.

Mutual Funds typically payout two types of income streams: dividends and capital gains.  Dividends are just like the dividends paid by an individual stock except the fund aggregates all the dividends paid by the companies the fund owns into a single dividend each quarter.  In the case of actively managed mutual funds, there may also be capital gains payouts.  These occur when the mutual fund manager sells out of a given security (or securities) and incurs a gain.  In this case, the manager would elect to distribute back some of the gain to you the shareholder.

As a mutual fund investor you have the option of electing to reinvest either (or both) the dividends and capital gains.  By electing this option instead of receiving cash when the fund pays a dividend or a capital gains payout, you will receive more shares of the mutual fund.  In essence, you are foregoing current income in order to continue building your position in a given strategy or index.  This option allows for easy account management by allowing you to focus on choosing the right mix of mutual funds and dollar cost averaging in over time.  But that isn’t to say that this is a set-it-and-forget-it strategy.  You still should review your investments periodically and make sure that the mix fits what you want.  Buying more of a mutual fund that isn’t going to perform well isn’t necessarily a good strategy!

These types of reinvestment programs can be helpful in making sure your account stays invested over time.  If you are someone who doesn’t like looking at your account every month or quarter and worries about making a timing mistake, these types of options may be helpful.  In this example we focused on retirement accounts but it is worth noting that reinvestment programs can be used in a brokerage account as well!

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