How to reduce taxes with a taxable investing account.

Earned income is the hardest income to protect from financial predators and we need to do all we can to reduce our tax burden. One of the best ways to do this is to use your taxable investing account as tax efficiently as possible. This article will enable you to do just that.

For most of the history of the income tax, long-term capital gains have been taxed at lower rates than ordinary income. The maximum long-term capital gains and ordinary income tax rates were equal only in 1988 through 1990 and this may again occur if Biden’s wealth tax becomes a reality. According to the current tax code, if you have 1 million dollar in capital gains it will be taxed to the maximum of 20% or so no matter your income. With the purposed tax plan anyone earning over $1 million of earned income would have to pay 37% tax on ever single dollar of long term capital gains. That’s almost double the long term capital gains rate.

Also with the current tax code, if you earned $1 million of income instead of acquiring $1 million dollars of long term capital gains, every dollar of that earned income above $500,000 would be taxed at 37% for single tax payers and every dollar over $600,000 would be taxed at 37% for those married filing jointly. This is a vast difference compared to the fact that every single dollar of long term capital gains is taxed at 20% with no cap. That is every single million dollars.

This then begs the question. Why on earth would anyone want to pay short term capital gains tax when the benefits of long term capital gains tax is so good? Well, speculators and short term traders do this all the time and this is a tax inefficient way to use a taxable investment account.

For example, You shouldn’t day trade in a taxable account if you are going to generate significant capital gains. If you want to day trade and produce significant capital gains then do so in a pretax account like a 401K, 457, or IRA. You can even use a post tax account like a Roth IRA or Roth 401K, or Roth 457. This would be the best tax efficient way to deal with the capital gains. On the other hand, if you are likely to lose money with day trading, which is usually the case, then it would be best to day trade in a taxable account, because you can then deduct the capital losses form your income or from capital gains from other transactions.

Taxable investing accounts in my book should be used for long term capital gains primarily with the harvesting of capital losses a secondary benefit. Short term capital gains should never happen in a taxable investing account period. For example, you should never sell a stock for short term capital gains because you need the cash. That is what an emergency fund is for. This is yet another reason why an emergency fund is always a prerequisite to investing in the stock market. We all have to realize that there is a difference between saving and investing. Your savings should never lose money, but your investment represents a portion of your savings that you are willing to put at risk and potentially lose. Conservative wealthy people do not put any of their savings at risk. Moderately wealthy people put 25 to 50% of their saving at risk and aggressive wealthy people put 50% or more of their savings at risk. Your savings is your emergency fund and whether you want have a 3 to 6 months emergency fund or invest 75% of your savings is subjective, but you should always have savings that is separate from investment dollars. This is because saving always comes before investing. There is no investing without first saving money. Don’t skip this step.

Your taxable investing account should be used to limit taxes by taking advantage of long term capital gains and to reduce your tax burden by harvesting and taking advantage of capital losses. This is best done with a buy and hold long term investing strategy. This is impossible to do as a stock market trader where you are dipping in and out of the market whether it’s daily, weekly or monthly. You only have to hold stocks for a year to reap the benefits of long term capital gains. To some this may feel like an eternity, but with a buy and hold investment strategy where you are holding each stock purchased for a minimum of five years with a preferable 10 to 15 year holding period, then achieving long term capital gains treatment is just a drop in the bucket.

Basic Principles Of Investing

Shares of stocks or index ETF should be bought or acquired in quantities of 10’s, 100’s and 1000’s of share. Try to acquire a minimum of 10 shares of each position. There are multiple ways to do this. You could limit the price of each stock or index ETF to $100 and just keep buying and dollar cost averaging until you have 10 shares. You could also microinvest and buy fractional shares. If for example you want to buy Amazon that costs $3K a share, you could buy 0.1 share or 10% of the share price a month until you have ten shares. If you were to continue to dollar cost average in this manner it would take approximately 10 years to accumulate 10 shares or you could buy an index fund and purchase thousands of fractional shares of stocks a year.

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The Worse Is Yet To Come

The funny thing is, I could have titled this post “the best is yet to come”, the reason being is that we are in a bubble and I have no idea when or where the top is. But what I do know is that there will be a market crash of epic proportions in the horizon. Likely within the next 2-3 years or so. So what are we to do?

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What’s Your Investment Gauge?

I was reading the White Coat investor’s blog the other day and he had written something that was very profound and it was a good gauge to test what level of investor you are. Here is the quote below

“I have often said that beginning investors have trouble following their plan at market lows, intermediate investors have trouble following their plan at market highs, and experienced investors follow their plan all the time. But that doesn’t mean that those experienced investors like the way it feels to be at market lows or at market highs.”

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Gamble The Right Way

I recently meet someone who works 3 clerical jobs in order to get by and receives dialysis 3 days a week. She revealed to me that she was investing in cannabis stocks. I felt so bad that someone with such a severe chronic condition is investing in such a volatile sector of the stock market. She could lose it all and in a heartbeat and doesn’t have much to fall back on. I tried to talk her into at least investing in index fund In order to lower her investment risk through diversification and lower cost funds and also about starting an emergency fund, but then I realized that we should all be good stewards of our money and manage our money wisely.

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Investing 101 for the buy and hold investor

Sometimes it’s hard to do what’s important and what matters as it pertains to investing. It’s not the return on your investments that ultimately matter, but its if you’re able to stay the course in order to get that long term compounding interest that will double and even quadruple your investments every 10 years or so. You see, when it pertains to investing, the proverbial chicken does actually come before the egg; and if you’re after that golden egg then staying the course is how to get your hands on that golden egg laying chicken.

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How to Avoid Speculative Investing

Delayed gratification vs. Impulsivity

Speculative investing

I recently wrote about having a reasonable investing plan and how important it is to have one, but It’s even more important to have an investment plan during times of market volatility than in bull markets. If not you may be investing speculatively and be unaware of it. Benjamin Graham once said The greatest danger investors face is acquiring speculative habits without realizing they have done so. This can happen so easily to many of us. The reasoning is simple. Because you see every battle is won before it’s fought and if you fail to plan then you will essentially plan to fail.

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How to Pay For College

College will likely cost between $60K and 100K a year in the next 20 years. This is based on the projected 3% yearly increase from the current average cost of $25K for public universities and $40K for private universities. The cost would increase to $240k and $400K respectively for a public and private college education. The thought of putting up to $400K in a 529 account when the future is unknown is just too risky for me. This is a huge sacrifice to make.

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