In today’s complex financial landscape, savvy investors understand that building a portfolio shouldn’t just be about maximizing your return for a certain level of risk. More and more people are starting to realize that you must consider the tax components of your investments, as it can have a big effect on what you are actually taking home. In this blog, we are going to explore some different strategies to consider as you build and monitor your portfolio. These strategies will allow you to maximize the amount you get to keep from the investments that you have spent years building.

The first concept we’ll explore is short-term and long-term capital gains. Understanding the difference between how both of these are taxed is essential to consider when dealing with investments. Short-term capital gains come from anything that has been held for one year or less, while long-term applies to anything that you have held longer than a year. Let’s consider why this matters. Short-term capital gains are taxed as ordinary income. That means if you are in the 35% federal bracket, a $1,000 gain really turns out to be a $650 gain. On the other hand, long-term capital gains rates are taxed either at 0%, 15%, or 20% depending on your income. Even if you are in the 20% bracket for long-term capital gains, you still save yourself 15% on taxes, or $150, by holding it longer than a year. In certain situations you might not have a choice between short-term or long-term gain, but this is something you need to keep in mind when watching your portfolio.

Another strategy to consider when evaluating your portfolio is the difference between municipal bonds and taxable bonds. Municipal bonds come in two forms: general obligation bonds and a revenue bonds. Both are tax-exempt, but general obligation bonds are backed by the credit and taxing power of the issuer while revenue bonds are tied to specific projects and carry slightly more risk. Tax-exempt bonds might sound appealing, but there’s a catch. Since these bonds are not taxable and are typically less risky than other types of bonds, they generally have lower return rates. It is important to remember that this strategy depends on your individual tax situation. If you’re in a low bracket, it may be worth opting for a taxable bond with a higher return. On the other hand, that lower return municipal bond may be worth it if you are in the highest tax bracket.

The last consideration we’ll discuss is the different buckets of investments and how they are treated differently for taxes. First, there are your taxable accounts, like brokerage accounts, where any investment income or capital gains are taxed immediately. On the other hand, some of your retirement accounts may be tax-deferred, allowing your account to grow tax-free until any distributions are taken out. Some of the most common accounts that are treated like this are IRAs and 401ks. There are also tax-free accounts, like a Roth IRA. You don’t get a tax deduction for contributions to these accounts, but they allow tax-free growth and distributions. These buckets of assets with different income tax treatment can be crucial to build up. Strategically picking which account to pull money from can help limit your taxes and allow you to keep more of your hard-earned money. Also, putting your more aggressive investments into your tax-deferred or tax-free accounts can be a great way to shelter any potential big gains.

A common phrase in the financial industry is “don’t let the tax tail wag the investment dog.” Essentially, this means that an investor shouldn’t allow tax considerations to dictate their investment decisions. While it is a good rule of thumb, it is still important to keep taxes in the back of your mind as you build and monitor your portfolio. As seen from the example above about short-term versus long-term capital gain treatment, it can make a big difference in what you actually get to take home.

If you have any questions about your portfolio and how to limit your taxation, feel free to reach out to us at info@jgua.com, or call us at 607-936-3785. We are here to help with everything your money touches.