Taxes are one of the largest and most controllable costs in investing. Here's how to structure your mutual fund holdings to keep more of what you earn.
Taxes are one of the largest — and most controllable — costs in investing. Most investors focus on picking funds and minimizing expense ratios. But tax decisions can quietly save or cost tens of thousands of dollars over a lifetime.
In a taxable brokerage account, you can owe taxes in two key ways:
Capital gains distributions: When a fund manager sells a stock at a profit inside the fund, that gain is distributed to all shareholders — including you. You owe taxes even though you didn't sell anything. Actively managed funds generate far more of these than passive index funds.
Dividends: Taxed at either the qualified rate (lower) or as ordinary income (higher), depending on the security and holding period.
When you sell: Gains held more than 1 year = long-term rate (15–20%). Under 1 year = short-term, taxed as ordinary income.
More tax-efficient:
Less tax-efficient:
Asset location means placing the right funds in the right account types.
In tax-advantaged accounts (IRA, 401(k), Roth IRA) — shelter these:
In taxable brokerage accounts — hold these:
Tax-loss harvesting is selling an investment at a loss to offset gains elsewhere. Sell a fund down $2,500 from purchase price, realize that loss, and use it to offset other capital gains.
Key rule: avoid the wash-sale rule — don't buy a "substantially identical" security within 30 days before or after. You can sell VTSAX and buy FSKAX (similar but not identical).
Related: Expense Ratios · Active vs. Passive Investing
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