it means, why it counts.
Provided by MidAmerica Financial Resources
A little phrase that may mean a big difference. When
you read about investing and other financial topics, you occasionally see the
phrase “tax efficiency” or a reference to a “tax-sensitive” way of investing.
What does that really mean?
The after-tax return vs. the pre-tax return.
Everyone wants their investment portfolio to perform well. But it is your
after-tax return that really matters. If your portfolio earns you double-digit
returns, those returns really aren’t so great if you end up losing 20% or 30%
of them to taxes. In periods when the return on your investments is low, tax
efficiency takes on even greater importance.
Tax-sensitive tactics. Some methods have
emerged that are designed to improve after-tax returns. Money managers commonly
consider these strategies when determining whether assets should be bought or
Holding onto assets. One possible method
for realizing greater tax efficiency is simply to minimize buying and selling
to reduce capital gains taxes. The idea is to pursue long-term gains, instead
of seeking short-term gains through a series of steady transactions.
Tax-loss harvesting. This means selling
certain securities at a loss to counterbalance capital gains. In this scenario,
the capital losses you incur are applied against your capital gains to lower
your personal tax liability. Basically, you’re making lemonade out of the
lemons in your portfolio.
Assigning investments selectively to tax-deferred and taxable
accounts. Here’s a rather basic tactic intended to work
over the long run: tax-efficient investments are placed in taxable accounts,
and less tax-efficient investments are held in tax-advantaged accounts. Of
course, if you have 100% of your investment money in tax-deferred accounts,
then this isn’t a consideration.
How tax-efficient is your portfolio? It’s an
excellent question, one you should consider. But this brief article shouldn’t
be interpreted as tax or investment advice. If you’d like to find out more
about tax-sensitive ways to invest, be sure to talk with a qualified financial
advisor who can help you explore your options today. What you learn could be
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indices are unmanaged and are not illustrative of any particular investment.
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