April 5, 2015
Why is it important to consider taxes when investing your money? How can you be tax efficient throughout the process?
Why is it important to consider taxes when investing your money? How can you be tax efficient throughout the process?
It is important to consider taxes when investing your money because there are different tax benefits available and you should know which one is right for you. The biggest examples that come to mind are a traditional vs. Roth IRA. The traditional IRA allows you to invest money before that money is taxed, making your total taxable income lower. When you pull the funds out in many years, however, your earnings are taxed. The Roth IRA allows you to invest money after it has been taxed. Then it can grow tax free, and if you follow all the rules when you pull the money out, your earnings will never be taxed. These are both a great benefit, but in order to get the maximum tax benefit for you, you must understand the difference and choose wisely.
Some investments are not tax efficent at all. Such as a Reit fund. A reit fund gives out a large amount of interest that is considered normal income. So you should always keep a reit fund in a retirement fund. Bonds are the same with paying out interest. Bonds should be kept in retirement funds unless you use them as an emergency fund for your savings. A good account to keep outside of a retirement fund would be a total stock market index, which has a low turnover and pays normal dividends and capital gains.
Great comments. Let’s recap.
(1) Invest in retirement accounts when possible to reduce (traditional) or eliminate taxes (Roth).
(2) When investing outside of retirement accounts, focus on index funds that don’t produce much income. This would take you to The Total Stock Market Index Fund or the Total International Stock Index Fund at Vanguard.
(3) Focus on long-term capital gains instead of short-term capital gains. You will end up keeping more of your money which will produce more money in your account thanks to that wonderful thing called compound interest. Awake to the possibilities!