Four Tax Time Tips for the Savvy Investor

By Ayesha Haider, AFC© Candidate, FINRA Military Spouse Fellow 

Tax time is often regarded with indifference by the passive investor and with dread by the active investor who is faced with capital gains tax on his or her yearly earnings. Regardless of which category you fall into, it is important to know how tax time can impact your investment and savings goals. The following tips illustrate how you can manage your portfolio to take advantage of the savings that tax time has to offer.

1. Clean house: It is highly unlikely that every asset in your portfolio has done well. Use tax time as a chance to clean house and sell some of those stocks that haven’t lived up to your expectations. Losses can be used to offset capital gains, allowing investors to avoid a 15 percent capital gains tax. Another interesting fact–up to $3000 of excess loss, not used to cancel gains, can be used to offset ordinary income. The remainder of the loss can be stored and carried forward indefinitely. Assessing your gains and losses during tax time also gives you the opportunity to re-evaluate your portfolio’s asset allocation strategy.

2. Hold for long-term gain: Capital gains tax for long-term holdings–those held for more than one year–is 15 percent. The tax for gains on short-term holdings (less than one year) is a whopping 28-40 percent depending on what tax bracket you’re in. Something as simple as holding your stocks for an extra day (to qualify as a long-term stock) can do wonders to reduce your annual tax bill.

3. Consider switching to an ETF: Mutual funds and managed accounts incur tax liabilities every time a security is bought or sold. As a rule of thumb, the higher the turnover is, the higher the tax bill, and this is passed on to the investor in the form of higher costs. Exchange Traded Funds or ETFs have very little turnover and thus have fewer capital gains transactions than an actively managed mutual fund.

4. Invest through your savings: Tax advantaged accounts such as 401(k)s and IRAs allow tax-free or tax-deferred growth of your investments. Furthermore, any money contributed to a 401(k) is exempt from current federal income tax, which will only be charged when you start withdrawing from the plan and are (in most cases) in a lower tax bracket. While these accounts may not give you the exact return or experience you would get from trading in the stock market, they do allow a wide array of investment options that meet most investors’ needs. Investing in tax-advantaged savings accounts will also contribute towards achieving your savings goals.

The tips outlined above provide some easy ways to take advantage of tax time savings for your investment portfolio. For more information on this subject, check out this Beginner’s Guide to Tax-Efficient Investing.

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