All you need to know about Reinvestment Options

If you’re running a successful business or own mutual funds, the extra income generated can be distributed amongst the investors or utilized to purchase additional shares—this is the basic definition of reinvestment. However, it can also be interpreted differently.

In the context of stocks, reinvestment can be the utilization of dividends to buy shares. Mutual funds also embody the concept of reinvestment as the deployment of dividends to purchase extra units of the same fund. In terms of tax gains, reinvestment is the consolidation of losses to offset the liabilities of capital gains.

Given below is a detailed explanation of different reinvestment schemes.

Dividend reinvestment plans

Dividend Reinvest Plans (DRIPs) are utilized by shareholders to invest money in a company as a long-term investment. The dividends that are gained can then be spent on the purchase of shares.

Cash is not offered to investors when the dividends are used on stocks that make up the fund. Instead, the cash is used by the fund-holders to buy additional fund units under the investor's’ name. Once the units are bought, they’re transferred into individual investor’s accounts. Upon the sale of fund units, the fund’s administrators attain a capital gain which will be worth more than the initial fund units.

Under this reinvestment scheme, there are a few benefits that can be gained.

DRIPs are commission-free and don’t require the services of a broker

They are flexible in nature, allowing investors to invest as per their income

The stocks have an average price fixed by a technique called dollar-cost averaging

There are discounts on the stocks that range between 1-10%

Tax gains on reinvestment

Capital assets, such as property, are subject to tax exemptions if there are any gains from a sale. Exemptions usually take place if a residential property is constructed or refurbished with the funds that arise by selling a capital asset. Capital gains, in such a case, are completely exempted from tax if the entire sales amount is reinvested. However, if the entire amount isn’t reinvested, exemptions are offered proportionately in the ratio of reinvested amount to total sale proceeds.

You can also use the capital gain from the sale of a house to pay off a Home Loan. However, use a housing loan calculator to figure out the Home Loan interest rate beforehand, so that you don’t pay more than you gain from the tax exemptions.

Mutual funds reinvestment for growth

Under the growth option for mutual funds, an investor will be barred from obtaining dividends paid by the stocks. This allows fund-holders to reinvest the money, which would otherwise have been paid to investors as dividend.

As a result, the Net Asset Value (NAV) of mutual funds escalates. The investor benefits by attaining a higher capital gain and maximizing the fund’s NAV on the same number of shares, initially bought by the investor. In this manner, the number of shares doesn’t increase, but the shares of the fund attain more value.

Reinvestment, in a nutshell, is an effective way of utilizing the extra income to gain more profits. Not only do you benefit from tax exemptions, but also acquire valuable stocks and bonds. However, if you’re in doubt, you should always seek help from financial experts before investing your money.

Arwind Sharma is a financial advisor with an experience of more than 7 years. He has worked for topmost financial firms in India and has been a visiting faculty at many reputed institutes in India.