No one likes to pay taxes. Although they are one of the two
certain things in life,
you want to do all you can to reduce this burden. The ways to
achieve that is through investing long term in mutual funds
specializing in broad asset classes and using tax-managed
Investors are subject to two forms of taxes. On bond interest,
you pay ordinary income tax. In addition, if you sell your
investments for a gain within a year of purchase, you pay tax at
ordinary rates, too.
However, if you have a profit from selling a security held for
more than one year, you get
, the long-term capital gains rate. For most taxpayers, it is no
higher than 15%.
As you can tell from the preferential tax treatment for
investors holding securities more than one year, investing for the
long term is better.
We are a major proponent of asset class investing, where you
invest in funds that give you exposure to large classes of similar
stocks, such as large U.S. companies or small international
developed market companies.
When you invest this way, you avoid trading in and out of
securities, because you stand pat with your broad-ranging funds.
The only time that you need to sell pieces of an asset class is
when you rebalance your portfolio toward your target
For the fixed-income allocation, investors can use municipal
bonds to get interest exempt from federal income taxes. In most
states, bond income from the investors who live there is free from
But are there ways to further reduce the tax burden? There
While we use asset class mutual funds to potentially save taxes, we
can use what is known as tax-managed funds, which aim to minimize
tax costs in the investment process.
The managers of these funds keep the tax impact low by avoiding
Some of the techniques include
tax lot accounting
(keeping a record of the purchase and sale price of each security
to get the best tax treatment) and
tax loss harvesting
(selling a security at a loss to offset taxable gains).
The tax managed funds that we use also run quantitative models
to evaluate the cost of executing a trade. All these strategic
moves seek to lower investors' taxable income.
What we like about using the tax managed funds is their ability
to adapt to the ever-changing tax code. The funds are able to make
changes to their operating procedures to reflect new rules.
For investors in the higher brackets, paying fewer taxes is a
substantial benefit. The next time you file your taxes, pay
attention to the amount of long-term gains in your taxable
portfolio versus short-term gains. Being smart about the tax
consequences of investing can turn a good portfolio into a great
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is the co-founder of
Crimmins Wealth Management LLC
in Woodcliff Lake, N.J. His blog is
Roots of Wealth
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