“Do you know the only thing that gives me pleasure?” once mused John D. Rockefeller. “It’s to see my dividends coming in.”

There is no doubt that dividends time always feels good. It’s not just well-deserved returns from the companies you are funding; it’s also a sweet reminder that investing works while you do other things, like spend time with family or hit the beach. Here at Betterment, we also use your dividends to keep your tax bill as small as possible.

Why are dividends important?

There are two opportunities for profit when you buy a share: when the value of the share appreciates, and when the share generates income, that is, dividends (your portion of a company’s earnings). Not all companies pay dividends, but as a Betterment investor, you almost always receive some as your money is invested across more than 3,500 companies in the world. And dividends make up a significant proportion of the total return you expect from investing in those companies.

Your dividends are also the essential ingredient in our tax-efficient rebalancing process. When you receive a dividend into your Betterment account, you are not only making money as an investor – your portfolio is also getting a quick micro-rebalance that keeps your tax bill down at the end of the year.

This is especially crucial after coming through a period of market volatility, like we did at the end of the last quarter. Big market changes have a tendency to shake things out of whack in your asset allocation. However, in order to control risk, you want to get back to your correct asset allocation as quickly as possible.

How tax-efficient rebalancing works

When your account receives any cash – whether through a dividend or deposit – Betterment’s software identifies which investments need to be topped up. Rather than using the new cash to buy shares according to your allocation, we automatically use the incoming dividend or deposit to buy more shares of the lagging part of your portfolio, and return the portfolio back to its original asset allocation. This is a sophisticated financial planning technique that traditionally has been only available to big accounts, but we make it possible to do it with any size account.

The secret is that we can do this because we handle fractional shares. That means every penny that enters your account reinforces full diversification. An upcoming brief from the Betterment research team will show more precisely the savings our tax-efficient rebalancing offers.

This contrasts with how many individual investors handle dividends on their own. Some online brokers offer an automatic option, and may reinvest dividends into whatever fund the cash came from. However, this blind reinvesting is not the most efficient use of dividends, and can very easily lead to a poorly allocated portfolio that requires a sell-off of gainers – and accompanying capital gains tax – to rebalance it over time.

Instead, our tax-efficient rebalancing helps you avoid such a “hard” rebalance which would require a major sale – or in tax terms, exposure to capital gains. For the DIY investor, this automated tax-efficiency is virtually impossible to achieve. At Betterment, it’s included on every dividend, every deposit, every time, for every client. And you do not need to do a thing.

This blog post was written with Dan Egan.

New to Betterment? As the most trusted online financial advisor, Betterment offers a fully diversified investment portfolio of 12 global asset classes, optimized to provide you the best possible returns for both retirement planning and wealth building. Betterment costs 0.15% of assets under management annually for a portfolio of $100,000 or more. Learn more here.

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