With the new tax law changes in recent years, managing taxes on your investments has become more important than ever for investors. There are some key wall street secrets that savvy investors use to maximize their after-tax returns. In this article, we will explore 3 important tips for tax efficient investing covering asset location, realizing losses, and mutual fund distributions. By properly implementing these strategies, you can potentially save thousands in taxes every year. Tax management should be a core part of your investing approach if you want to build long-term wealth. There are a number of other useful tax reduction strategies as well when it comes to investing, but these 3 tips are a great starting point for individual investors looking to improve their after-tax returns.
Asset location is crucial for minimizing taxes on investments
One of the key wall street secrets is making sure your assets are in the right accounts based on their tax treatment. This strategy is known as asset location. The basic principle is to hold your most tax-efficient investments like index funds and etfs in taxable accounts, while keeping your tax-inefficient investments like active mutual funds in retirement accounts. This helps reduce the drag on your returns from taxes. For example, keeping a total stock market index fund in your Roth IRA while putting your actively managed emerging markets mutual fund in your taxable brokerage account is far more tax efficient. You want to limit taxable events like capital gains distributions and turnover in your taxable accounts. Maximize the use of tax-advantaged accounts like 401ks and IRAs for your least tax-friendly assets. Taxes can take a big bite out of returns over time, so proper asset location is critical.
Tax-loss harvesting can offset capital gains and reduce your tax bill
Another important tax minimization technique is tax-loss harvesting. The basic concept is that you can sell investments at a loss to offset capital gains you have realized. For example, if you realized a $10,000 capital gain from selling stock but have a $5,000 loss on another investment, you can harvest that loss to bring your net capital gain down to $5,000. This directly reduces your tax liability for that year. Tax-loss harvesting becomes even more powerful if you have losses in excess of your gains – you can use up to $3,000 per year to offset ordinary income. Any remaining losses carry forward to future tax years. The key is being able to generate losses in your portfolio on an ongoing basis both to offset capital gains and ordinary income. Pay attention around year end for opportunities to lower your tax bill.
Manage mutual fund distributions to control taxes
Finally, pay close attention to mutual fund distributions in your taxable accounts. Many mutual funds will make taxable distributions throughout the year in the form of capital gains and dividends. These distributions can create big tax bills even if you don’t sell any shares. Actively managed stock mutual funds tend to have larger taxable distributions versus index funds and etfs. One strategy is choosing mutual fund share classes like institutional or ETF versions that are more tax efficient. You may also want to avoid buying right before a distribution if possible. Keeping mutual funds in retirement accounts avoids this issue altogether. Managing fund distributions along with asset location and tax-loss harvesting are key wall street secrets for reducing your investing tax bite.
In summary, savvy wall street investors utilize strategies like asset location, tax-loss harvesting, and managing mutual fund distributions to maximize after-tax returns. Paying attention to taxes can lead to thousands in savings over the long run. Make sure you hold the right assets in the right accounts, offset capital gains with losses, and watch out for taxable mutual fund distributions. With the proper tax-efficient investing techniques, you can keep more of your investment returns.