Tax Management: 4 Key Areas For Investors

Improper tax management can cost you more than a quarter of your long-term return, severely limiting spending power in retirement. The good news is that taxes can be managed. There are four key areas where investors can place their tax focus:

Tax Efficiency

Thousands of potential investment vehicles exist today, each with radically different tax implications. Choosing and using tax-efficient investments is a vital first step toward keeping more of your money. Here are some general guidelines when it comes to common investment vehicles:

MUTUAL FUNDS are notoriously bad in terms of tax management.

EXCHANGE TRADED FUNDS (ETFs) are generally more tax efficient than mutual funds.

INDIVIDUAL STOCKS can be the most tax-efficient way to gain exposure to equities.

BOND ETFs and passive bond mutual funds are generally more tax efficient than actively managed bond mutual funds, but the tax treatment of income generated from bonds differs from that of equities.

REAL ESTATE INVESTMENT TRUSTS (REITs) dividends are generally taxed as ordinary income to shareholders.

Tax Location

If you have multiple investments, do you consider the most appropriate account for each of your assets? If not, you should. Each of your accounts has unique tax characteristics, and if you understand these characteristics, you can place your assets in the most advantageous accounts, thereby minimizing your tax liabilities. This is called tax location. Depending upon the underlying characteristics of the investment, strategically placing it in either a taxable, tax-deferred, or tax-exempt account may improve your annual return.

So what securities go where? One general rule is to place high-yield stocks in tax- deferred or -exempt accounts, like IRAs and Roth IRAs, and low-yield or no-yield?stocks in taxable accounts. Fixed income investments are a little trickier. It’s good to keep in mind, optimizing around long-term growth rates and tax rates can get very complicated, so you should consult a professional.