You've Got Questions, I've Got Answers
Charles B. Carlson, CFA
Contributing Editor, Dow Theory Forecasts
Here are answers to frequently asked investment questions:
Q: If I reinvest my dividends to buy additional shares of stock, do I pay taxes on those dividends even though I don't receive them in cash?
A: Yes. Whether you reinvest dividends or take possession of them in the form of cash, you are responsible to pay taxes. Dividend income is taxed at your ordinary tax rate.
Q: If I sell only part of a particular stock holding, may I use the average cost method for determining my cost basis?
A: You cannot use an average cost method for individual stocks if you sell only a portion of a particular holding. If you sell ALL the holding, however, you can use an average cost determination.
Q: How do I determine a stock's "yield"?
A: A stock's yield is determined by dividing the stock's annual dividend by the stock price. For example, a stock that trades for $20 per share and pays an annual dividend of $1 per share has a yield of 5% (1 divided by 20).
Q: Are commissions part of my cost basis for a particular stock?
A: Yes. When determining your cost of purchase, you should include the commissions as well as the amount of your investment.
Q: Do stock splits matter?
A: Stock splits shouldn't matter to investors since a stock split is the same thing as getting two tens for a twenty. No real value is created; you just have more paper. Having said that, there has been academic work that has shown that stocks that split seem to get a short-term pop from investors. Once reason may be that companies that split usually boost the dividend, too. Another reason is that a stock split may be a signal from the company that business is strong. Keep in mind that there is a cause/effect issue at work. Do stocks improve because of a split? Or do good stocks split because they are, well, good stocks whose price is consistently rising? I believe the latter more than the former.
Q: How many stocks do I need in order to be properly diversified?
A: You can have decent portfolio diversification by owning 13 to 17 stocks, providing the stocks aren't all in the same industry sector. Once you get to, say, 25 or 30 stocks, adding any more stocks provides very little benefit in terms of diversification. Plus, having a lot of stocks complicates your record keeping.
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