As we get closer to April 15, the tax-filing deadline, you may be wondering about the effects of some of your actions on the amount of taxes you pay. Of course, you don’t have total command of some key tax-related components, such as your earned income. But one area in which you do have a degree of control is your investment-related taxes. And since 2013 has been a pretty good year for the financial markets, you may have some sizable gains. If you decide to sell some of your investments to “lock in” those gains, what would be the tax consequences?
Essentially, the answer depends on two variables: your tax bracket and how long you’ve held the investments.
Our tax code rewards those investors who hold their investments for longer time periods. Consequently, short-term capital gains, earned on investments held for less than one year before being sold for a profit, are taxed at an individual’s ordinary income tax rate, which, in 2013, can be as high as 39.6%. However, long-term capital gains, earned on investments held one year or longer, are taxed at just 15% for most taxpayers and 20% for those in the 39.6% bracket. (At this tax bracket, a 3.8% Medicare contribution tax may also apply to long-term gains, so the top capital gains rate would be 23.8%.) You’ll need to check with your tax advisor for more details.
From a tax standpoint, you are likely to be better off by keeping your profitable investments at least one year before selling them. But are there also other reasons to hold investments for the long term?
In a word, yes. For one thing, if you are constantly buying and selling investments, you won’t just incur taxes — you’ll also rack up commissions and fees. And these costs can eat into your investments’ real rate of return.
Also, if you are always buying and selling, you may be doing so for the wrong reasons. You might be chasing after “hot” investments, even though by the time you buy them, they may already be cooling off — and, in any case, they may not even be right for your needs. Or, you might decide you need to “shake things up” in your portfolio because you haven’t liked what you’ve seen on your investment statements for a longer period of time. But if the overall market is down, it tends to drag everything down with it — even quality vehicles that still have good prospects.
But most importantly, if you are always buying and selling, you will find it difficult to follow a unified, long-term investment strategy — one that’s based on your goals, risk tolerance and time horizon. When you follow such a strategy, you may indeed buy and sell investments, but only at those times when it’s really necessary, such as when you need to further diversify your holdings, a fundamental change in the company has occurred or when the suitability rating of the investment has changed. While diversification can’t guarantee profits or protect against loss, it can help reduce the impact of volatility on your portfolio.
If you want to cut down on your capital gains taxes, holding quality investments for the long term makes sense. And for an investment strategy, a “buy and hold” approach can better position you long after tax season has ended.
Scott Johnson, CFP, is a financial advisor with Edward Jones, 8146 W. 111th St., Palos Hills, 974-1965. Edward Jones does not provide legal advice. This article was written by Edward Jones for use by your local Edward Jones financial advisor.