Tax-efficient investing is key to meeting long-term investment goals, and strategies such as tax loss harvesting and asset location can significantly decrease taxes.
Investment strategies that optimize tax efficiency require careful preparation. Start by filling up tax-advantaged accounts and rebalancing taxable accounts so as to maximize tax savings.
1. Invest in Tax-Advantaged Accounts
Taxes are an inevitability in investing, yet often fall to the wayside when making decisions. By investing in tax-advantaged accounts such as an IRA, 401(k), 529, or HSA you may be able to reduce taxes and keep more of your savings invested instead of being taken out in taxes.
Tax-efficient investing shouldn’t replace your overall investment strategy. But taking steps to minimize tax loss could pay dividends down the line – particularly as you prepare for retirement. A few simple strategies can make investments more tax efficient and help put you on a better path toward reaching your financial goals.
2. Focus on Long-Term Investments
Tax considerations often fall below the radar when it comes to long-term investment performance, yet each dollar paid in taxes reduces returns accumulated from investments, creating a cumulative loss over time.
Tax rates and rules may change from time to time, but there are numerous steps you can take to reduce the amount of money you pay in taxes. From simple strategies like investing for long-term gains rather than day trading to prioritizing paying off short-term debt before investing (interest on debt is usually much higher than returns from most investments), there are ways you can minimize how much you owe.
3. Avoid Trading
Uncle Sam will always take their cut of your investment gains; however, there are ways you can reduce how much of that goes toward taxes. Partnering with a fiduciary who offers customized financial plans with tax-efficient investing strategies may help.
Hands-off buy-and-hold investing is one of the best ways to limit taxable capital gains realization. Tax loss harvesting may also help, which involves selling securities at a loss in order to offset taxable gains from other securities. While tax loss harvesting is an effective strategy for lowering overall taxes burdens, be wary not to trigger wash sale rules (designed to prevent investors from artificially creating losses by selling and repurchasing within 31 days).
4. Invest in Tax-Advantaged Funds
Investors spend hours seeking out stock and bond funds with optimal return prospects; however, tax efficiency should also be an essential element when investing for long-term projects.
An investment with higher expected returns but lower tax rates can still leave you with more money, allowing for better overall portfolio performance. When rebalancing, it is equally important to balance tax rates across accounts and assets.
Tax-efficient investing employs various legal strategies to legally reduce, defer or avoid paying taxes on investment gains. By keeping more of your returns you can reach your investment goals more quickly. A financial advisor can assist in developing a tax-efficient investing plan tailored to your specific needs.
5. Invest in Tax-Advantaged Accounts
Taxes shouldn’t be overlooked when considering investment returns; as each dollar you pay in taxes reduces how much of your return you get to keep for yourself.
Investment selection and placement is key to tax efficiency, and some investors prefer holding bond funds in tax-advantaged accounts because dividend yields generated are taxed at ordinary income rates whereas stocks gain from price appreciation that’s often taxed at capital gains rates. When rebalancing portfolios it is also vital to keep taxes in mind as you sell or acquire assets so as to achieve your target asset allocation as efficiently as possible while still meeting long-term returns of the portfolio.