Permanent Value

Week In Review 3/27/14

Bruce Doole
March 27th, 2014

The Importance of Tax-Efficient Investing
When it comes to income, you know that it’s not what you make, but what you keep after taxes that really counts. And these days, with higher capital gain taxes and the 3.8% Medicare investment income surtax (that affects certain filing status thresholds), being mindful of investment taxes is more important than ever.

Return lost to taxes

Because mutual funds may distribute capital gains throughout the year, mutual fund investors are often concerned about losing investment returns to taxes. But individual stock and bond investors are vulnerable to taxes as well, depending on how they manage their investments.

Other considerations

In general, holding tax-efficient investments in taxable accounts and less tax-efficient investments in tax-advantaged accounts should add value over time. However, there are other factors to consider, including:

Active trading by individuals or by mutual funds, when successful, tends to be less tax-efficient and better suited for tax-advantaged accounts. A caveat: Realized losses in your tax-advantaged accounts can’t be used to offset realized gains on your tax return.

Estate planning issues and philanthropic intent might play a role in your portfolio planning. If you’re thinking about leaving stocks to your heirs, stocks in taxable accounts are generally preferable. That’s because the cost basis is calculated based on the market value of the stocks at the time of death (rather than at the time they were originally acquired, when they may have been worth substantially less). In contrast, stocks in tax-deferred accounts don’t receive this treatment, since distributions are taxed as ordinary income anyway. Additionally, highly appreciated stocks held in taxable accounts for more than a year might be well-suited for charitable giving because you’ll get a bigger deduction, and the charity gets a bigger donation, than if you liquidate the stock and pay long-term capital gains tax before donating the proceeds.

The Roth IRA might be an exception to the general rules of thumb discussed above. Since qualified distributions are tax free, assets you believe will have the greatest potential for higher return are best placed inside a Roth IRA, when possible.

The bottom line

You have a lot of control when it comes to maximizing your after-tax wealth. First, decide on a suitable asset allocation. Next, select low-cost investments that make sense for you. Then, be tax-smart about where you hold your investments.


This Week’s Economic Data

-Industrial production rebounded 0.6% after dipping 0.2% in January.
-The Consumer Price Index held steady at 0.1% for February, equaling the January pace and meeting analysts’ forecasts.
-Housing starts nudged down 0.2% in February to a 907,000 annual rate from an upwardly revised 909,000 rate for January.
-Initial jobless claims came in at a lower-than-expected 320,000 for the week of March 15 versus 334,000 for the week of February 15.
-For the sixth time in seven months, existing homes sales contracted, at minus 0.4% in February following a severe 5.1% contraction in January.
Source: Charles Schwab/ Ivy Funds