When it comes to successful long-term investing, keeping costs low is crucial. However, one cost that is often overlooked is taxes. While much attention is given to tax rates on income and capital gains, the location of where you hold certain investments can also impact your overall tax bill.
High-income or capital-gain generating investments are best held in tax-advantaged accounts like an IRA, rather than taxable brokerage accounts. If you rely on the income from these investments for short-term needs, it’s important to consider accessibility without incurring penalties.
Here are five investments that should not be held in taxable accounts:
1. Taxable bonds
While taxable bonds can provide income, the interest earned is typically taxed at ordinary income rates, reducing your overall return as an investor. Municipal bonds, on the other hand, are a good fit for taxable accounts as their interest income is often tax-exempt.
2. Real estate investment trusts (REITs)
REITs offer exposure to the real estate market and high dividend yields. Holding REITs in a tax-advantaged account can help you avoid taxes on the income, making them a better option than in a taxable account.
3. Dividend-paying stocks
Dividend stocks can generate income and grow your wealth, but holding them in a taxable account may subject you to higher tax rates. Consider a traditional or Roth IRA for holding dividend stocks.
4. Actively managed mutual funds
Active funds can create tax headaches due to high portfolio turnover and capital gains distributions. Low-cost index funds and ETFs are more tax-efficient options for investors.
5. Balanced funds
Balanced funds that hold a mix of stocks and bonds can generate taxable income and capital gains. Consider holding balanced funds in a tax-advantaged account to minimize tax implications.
Conclusion
While these investments can be valuable assets, holding them in tax-advantaged accounts can help shelter them from taxes. It’s important to conduct independent research and consider the tax implications of your investments before making decisions.
Editorial Disclaimer: All investors should conduct their own research into investment strategies before making decisions. Past performance is not indicative of future results.