Smart investing is about more than picking the next Apple. The best investors ruthlessly cut costs wherever they can. You can think of it as plugging leaks. There's no point pouring water into a bucket if it's full of holes. But a lot of investors try to invest with a leaky bucket.
Fund fees are one hole. Transaction commissions are another. And the biggest hole in many investors' bucket is taxes.
People don't like to think about taxes, because they're complex. But if you lack a tax strategy, your actual investment returns could be a lot lower than you expect.
Luckily, there are some simple ways to shrink your tax bill, build wealth faster, and avoid a nasty surprise when you're 65. FutureAdvisor's premium clients get their investments balanced in a tax-efficient way.
The easiest way to save on taxes is to put the right assets into the right accounts. What does that mean?
If you have a normal brokerage account -- at an online brokerage like Schwab or E*trade -- then you're on the hook for taxes when you sell your investments there. (Obviously, you only pay taxes if they grow in value, not shrink.)
But that's not true in a traditional IRA or 401k. As long as you leave the money in the account, you can buy and sell whatever you want, and you won't be taxed on it until you retire.
Traditional IRAs and employer-sponsored retirement accounts like 401ks are tax-deferred. That means your wealth is sheltered, and you can accumulate interest on your interest until you withdraw the money decades from now.
(With Roth IRAs, you pay tax before you invest and all returns are tax-free, which is great for young people in lower tax brackets who expect to progress to a higher one.)
Tax-deferred accounts are useful even if you don't plan on selling anything. Dividend-rich stocks and high-yield bonds -- really anything throwing off cash -- are probably best held in a tax-deferred retirement account, where you can reinvest your returns without an immediate tax hit. Think of it like borrowing money from the IRS for decades, and earning interest on that loan.
There are lots of legal nuances that you'll need to be aware of if you're going to cut your tax exposure. (Example: Did you know that municipal bonds are exempt from federal taxes? That's one argument in favor of putting them into your taxable brokerage account.)
You can either study tax law yourself, or let FutureAdvisor help you allocate your assets with tax-efficient investing. We've done the homework for you - all that's left to do now is rebalance your accounts.