Choosing to reinvest your capital gains means that your broker keeps all your money working for you rather than leaving any in cash on the sidelines. This can maximize your returns, and take you out of the investing equation for the most part. It's a great option for a hands-off investor.
However, reinvesting capital gains isn't all upside. For example, if you aren't sure you'll have the cash to pay your capital gains taxes at the end of the year, reinvesting them doesn't provide you with overwhelming benefits. The cash has to come from somewhere, and it might as well come from the gains you're paying tax on. In addition, if you've reached an age at which you have to take a disbursement, choosing not to reinvest those capital gains can count toward your required minimum distributions and reduce the fees you pay when cashing out investments.
Taxation and reinvesting capital gains
Whether you reinvest your capital gains or not, you're likely to accumulate some amount of tax liability related to the investment. If your investment is held in a taxable account, the gains are always taxable for that year, even if you choose to reinvest them.
However, if your capital gains are held in an IRA, 401(k), or other tax-deferred retirement account, the taxes will come due when you withdraw the funds in retirement. In addition, capital gains from municipal bond funds may be completely tax-exempt if your state doesn't tax them; these funds are completely tax-exempt at the federal level.