Why You Should Thank the Taxman Today
From the Baltimore Clubhouse – Let the murmur of defeated sighs commence…
It’s Tax Day.
For many investors, today is like the 13th floor of a hotel… one you’d much rather skip over.
But today I’m going to tell you why – instead of planning his unfortunate demise – you should be thanking the taxman…
Not just once, but twice.
Before you shrug me off, I’m not going to pretend there’s a way to avoid paying taxes altogether.
And we shouldn’t. Paying taxes is one of our civic duties. Taxes help keep our schools open, elderly cared for and country safe.
But here’s the hard truth…
As much as we gripe about taxes, we don’t live in a high-tax country.
When we look at taxes as a share of our economy, we see the U.S. is 25% below the average.
Taxman? Thank you for keeping our taxes so low compared to those in other countries.
I’ll admit, that one felt a little strained.
It’s still hard not to cringe when we see more than a third of our annual income go to the IRS.
So I’ll give you another reason why we should thank the taxman…
The Vanguard Group of mutual funds conducted a study that indicates the average investor gives up 2.4% of their annual returns to taxes.
If you trade frequently, it’s likely much higher. We can also estimate that most investors give up at least 1.9% a year in commissions, management fees, 12b-1 expenses and other costs.
Ouch.
It’s no coincidence that the Fourth Pillar of Wealth is “Cut Investment Expenses… and Leave the IRS in the Cold.”
The premise is simple…
Structure your portfolio in a way that makes it nearly impossible for the IRS to take anything.
Here’s how you do it:
- Stick to quality. Higher-quality investments mean less turnover. And less turnover means less capital gains tax. The less you trade your Core Portfolio, the fewer tax liabilities you incur. As Warren Buffett warns, “The capital gains tax is not a tax on capital gains; it’s a tax on transactions.”
- Hang on for 12 months. Anything sold in less than 12 months is a short-term capital gain. And short-term gains are taxed at the same level as earned income, which can be as high as 35%. But long-term gains are taxed at a maximum rate of 15%. Even better, do your short-term trading in your IRA, where the gains are tax-exempt.
- When you stop out in less than 12 months, offset your capital gains with capital losses. The IRS allows you to offset all of your realized capital gains by selling any stocks that have created a realized loss. You can even take up to $3,000 in losses against earned income. Not selling your occasional losers is not only poor money management, but poor tax management.
- Avoid actively managed funds in your nonretirement accounts. Managed funds often have high turnover, and federal law requires them to distribute at least 98% of realized capital gains each year. You can get hit with a big capital gains distribution even in a year when the fund is down.
- Own high-yield investments in your IRA, pension, 401(k) or other tax-deferred account. There’s no provision in the tax code to offset your dividends and interest. So do the smart thing. Own big income payers like bonds, utilities and real estate investment trusts in your IRA.
Based on our research, simple changes like these can have a big effect on your wealth…
By reducing your expenses to 0.3% annually and tax-managing your portfolio, you’ll retain an additional 4% of your portfolio’s return each year.
Over time, that adds up.
Consider this: Over the past two centuries, the U.S. market has returned an average of 11% a year.
We asked our Research Team to show us how a $100,000 portfolio grows at this rate – with and without the drag of high expenses and taxes.
The results are astounding…
After 20 years, a cost-efficient, tax-managed portfolio will return 108.3% more than the average portfolio. That’s an extra $419,000.
So, without further ado, I’d like to extend a second “thank you” to the taxman for giving us profitable (and legal) ways to stiff him.
If you’re finding it tough to thank the taxman today, I challenge you to follow our five steps to tax-managing your portfolio between now and April 17, 2018.
You may find yourself singing a different tune.
Good investing,
Rachel