Many investors believe they need to make investment decisions with their tax situation in mind, and they’re often right — but not always.
There’s a phrase that goes, “Don’t let the tax tail wag the dog.” That means you should not try to optimize your investment decisions too much for taxes. My philosophy is quite simple and has done me well over the years: Invest money for growth wisely and let the taxes fall where they may.
Some tax-based stock decisions make perfect sense. For example, if you have held a stock in a taxable account for 361 days and you are thinking of selling it, I would strongly be in favor of waiting five more days to establish long-term capital gains treatment.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
If a stock is held for 365 days or longer, then you pay a lower federal capital gains tax rate. The tax for long-term gains is 20% for those in the higher income tax brackets. For short-term capital gains (on investments held less than 365 days), you will pay ordinary income tax rates — which for high earners can be as high as 39.6%. Trying to hold for long-term capital gains is certainly worth it, and would help reduce the tax bracket to 20% from what could be over 39%. This is good tax planning.
However, if you need to sell a stock to protect principal, the tax issue should really be irrelevant. Also, whenever we buy a stock, we hope we can keep it for three, five or 10 years or longer — which, of course, would be great from a tax perspective. If you do hold for 10 years, there are no taxes at all (on the gains) over this time period. Of course, once you sell the stock, taxes will be due.
I’m a staunch advocate of investing in growth stocks, which have a lifecycle. Once you have determined that the growth phase is over and the stock has principal risk, then you must act to protect principal, and the only way to do that is to sell.
Yes, you will have to pay a tax, and hopefully by that point it’ll be a long-term capital gains tax. However, this tax cost is simply an overall cost of growing your funds over time. I do not believe you should sell a gain in your portfolio every time you sell a loss. Some investors try to offset all gains with losses to avoid taxes, but doing so may mean you are selling a stock far too prematurely.
Finding great investments is hard work, and keeping them through their ups and downs is a worthy, but difficult goal. Don’t let the potential tax consequences lead you astray when it comes to making investment decisions.
Rob Lutts is president and chief investment officer of Cabot Wealth Management and the author of The Great Game of Business: Investing to Win.
-
What to Do About These Three Medicare Changes During Open EnrollmentWith costs due to rise sharply next year, look for coverage that protects your wallet as well as your health.
-
Use the 'Newton Rule' to Grow Your 401(k) Retirement SavingsHarnessing Sir Isaac Newton's rule of retirement can boost your 401(k) savings while you chill.
-
Are You a Small Business Owner Buckling Under Economic Pressure? Here's How You Can CopeSignificant emotional and financial challenges, including tariff worries, are piling up on small business leaders. Here's how leaders can develop more healthy coping strategies and systems of support.
-
To Raise Prices or Not to Raise Prices: Tariff Tips for Small BusinessesSmall businesses are making critical decisions. Should they pass on higher costs due to tariffs, or would that only cost them more in lost customers?
-
Five Retirement Planning Traps You Can't Afford to Fall Into, From a Wealth AdviserTo help ensure you reach your savings goals and enjoy financial security in your golden years, be aware of these common pitfalls. The key is to be proactive, informed and flexible.
-
Your 401(k) Can Now Include Alternative Assets, But Should It? A Financial Adviser Weighs InMany employer-sponsored plans offer limited investment options, which can stunt growth. But participants considering alternatives might need some sound advice to get the most from their accounts.
-
Will Taxes Shred Your 401(k) or IRA During Your Retirement? It's Very LikelyConventional wisdom dictates that you save in a 401(k) now and pay taxes later, but turning that rule on its head could leave you far better off. A financial planner explains why.
-
More Retirees Are Renting: Should You? A Financial Adviser Weighs InIn some ways, renting is cheaper, more flexible and easier, but unless you understand the implications for your taxes and health costs, it might not be for you.
-
I'm a Real Estate Investing Pro: This 1031 Exchange Strategy Can Triple Your Cash FlowSavvy investors can use 1031 exchanges to unlock value by moving capital across markets in a play called geographic arbitrage. These tax implications can make or break the strategy.
-
I'm an Insurance Pro: Everyone Needs to Prepare for Earthquakes, Even if You Don't Live Near a Fault LineHere are my tips for what to do before, during and after an earthquake. The more prepared you are, the more you'll be able to keep your wits about you if it happens.
