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Tax Optimization

How We Use Your Dividends To Keep Your Tax Bill Low

Every penny that comes into your account is used to rebalance dynamically—and in a tax-savvy way.

Articles by Dan Egan

By Dan Egan
Managing Director of Behavioral Finance & Investing, Betterment  |  Published: March 25, 2019

Even small dividends are essential to helping your portfolio grow over time—because we can invest in fractional shares.

Deposits and dividends help us rebalance your portfolio more tax-efficiently, which keeps you at the right risk level while keeping your tax bill low.

There is no doubt that dividends always feel 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.

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

John D. Rockefeller.

Here at Betterment, we also use your dividends to keep your tax bill as small as possible.

Dividends Boost Your Total Returns

There are two opportunities for profit when you buy a share: when the value of the share appreciates, and when the share generates income in the form of dividends. Dividends are your portion of a company’s earnings. Not all companies pay dividends, but as a Betterment investor, you almost always receive some because your money is invested across more than 3,000 companies in the world. Dividends make up a significant proportion of the total return you can expect from investing in those companies.

Performance of S&P 500 With Dividends Reinvested

Graph showing more returns with reinvested dividends compared to no dividends

Source: Bloomberg

More Opportunities to Rebalance Your Portfolio

Your dividends are also an 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 helps keep your tax bill down at the end of the year.

This is especially crucial after coming through a period of market volatility. Big market changes have a tendency to cause your asset allocation to veer off course. However, in order to better control risk, you want to get back to your correct asset allocation as quickly as possible. Reinvesting dividends helps to get you back on track by allowing us to buy assets that you are underweight in, rather than sell assets you are overweight in.

Dividends + Deposits = Tax-Efficient Rebalancing

When your account receives any cash—whether through a dividend or deposit—we automatically identify which investments need to be topped up. When market movements cause your portfolio’s actual allocation to drift away from your target allocation, we automatically use any incoming dividends or deposits to buy more shares of the lagging part of your portfolio. This helps to get the portfolio back to its target asset allocation without having to sell off shares. This is a sophisticated financial planning technique that traditionally has only been available to big accounts, but our automation makes it possible to do it with any size account.

The Final Puzzle Piece: Fractional Shares

The secret is that we can do this because we handle fractional shares. That means every penny that enters your account reinforces full diversification.

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 often not the most efficient use of dividends, and can very easily lead to a poorly allocated portfolio that requires a sell-off of assets at a gain—with the accompanying capital gains taxes—to rebalance it over time.

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

Ready to start earning dividends?

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