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Here’s How to Minimize Taxes When Investing

managing investments for tax efficiency

is an important aspect of growing a

portfolio gains from investments are

subject to taxes just like any other

form of income however taxes erode

returns and consequently reduce a

portfolios growth being tax efficient

with your investments allows more money

to be reinvested back into a portfolio

and lets it grow over time

there are generally two categories of

taxes on investments short-term capital

gains and long-term capital gains

short-term capital gains are typically

taxed at higher rates like ordinary

income examples include interest income

and realized gains on investments

purchased and sold in under 1 year

long-term capital gains on the other

hand are usually taxed at a lower rate

examples include qualified dividend

income and realized gains on investments

held over 1 year because tax rates

differ short-term capital gains are

generally taxed inefficient while long

term capital gains are relatively tax

efficient examples of tax inefficient

investments include junk bonds preferred

stocks and other interest bearing

investments such as money market

accounts these investments are

considered tax inefficient because most

if not all games are typically received

as ordinary income because the gains are

treated like ordinary income they can be

taxed at higher rates than long-term

capital gains

conversely examples of tax-efficient

investments include convertible bonds

and common stocks games from

tax-efficient investments tend to come

more from price appreciation and less

from income because gains from

tax-efficient investments can be

long-term capital gains there possibly

subject to lower tax rates one way to

reduce the tax burden is to hold tax

inefficient investment within a tax

deferred account tax deferred accounts

include 401 K S 403 B's and individual

retirement accounts also known as IRAs

these accounts defer taxes on gains

until after retirement

this means gains from tax inefficient

investments can be taxed less if kept in

a tax deferred account until after the

legal age of retirement tax deferred

retirement accounts can help manage tax

inefficient gains

investors can manage tax-efficient

investments in taxable accounts because

gains from tax-efficient investments

such as convertible bonds and common

stocks are generally taxed at lower

rates some investors hold these

investments in a taxable account

investors may want to consider trying to

hold investments in a taxable account

for over a year to classify gains as

long-term capital gains and benefit from

relatively lower taxes managing for tax

efficiency in these ways can contribute

to greater growth in a portfolio over

time to better understand how taxes

impact the growth of a portfolio let's

look at two portfolios that manage taxes

differently suppose that two tech scible

portfolio start with a balance of

$100,000 and grow 7% every year for 30

years after paying taxes gains are

reinvested in each portfolio the first

portfolio holds tax inefficient

investments such as junk bonds and money

market accounts let's suppose gains on

these investments are taxed at 28% every

year before reinvestment after 30 years

the portfolio would grow to four hundred

thirty seven thousand one hundred sixty

one dollars now let's contrast that

portfolio against another with a lower

tax rate the second portfolio holds

tax-efficient investments such as

convertible bonds and common stocks

let's suppose gains on these investments

are taxed at 15% before being reinvested

the taxi fishing port folio would grow

to five hundred sixty six thousand two

hundred seventy seven dollars in this

example managing for tax efficiency

would have resulted in a difference of

about one hundred twenty nine thousand

dollars as the example demonstrates

taxes can have a big impact on a

portfolios growth over time to reduce

the tax burden an investor may want to

consider holding tax inefficient

investments such as junk bonds and

preferred stocks and a tax deferred

account

additionally called tax-efficient

investments such as common stocks in a

taxable account so gains can be

reinvested but keep in mind that taxes

are a complex issue and no two

situations are the same be sure to speak

with your accountant or tax advisor

before making investing decisions based

on taxes

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