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 paid to tax rates on income and capital gains, the location of your investments can also impact your tax bill.
High-income or capital gains-generating investments are best held in tax-advantaged accounts like IRAs, rather than taxable brokerage accounts. If you need regular access to the income from these investments, make sure you choose an account that allows for withdrawals without penalties.
Here are five investments you should avoid holding in taxable accounts:
1. Taxable bonds
While taxable bonds can generate income for investors, the interest income is typically taxed at ordinary income rates, reducing your overall return. Consider municipal bonds, which offer tax advantages, for your taxable accounts.
2. Real estate investment trusts (REITs)
REITs provide exposure to the real estate market and often come with high dividend yields. Holding REITs in a tax-advantaged account can help you avoid taxes on the income.
3. Dividend-paying stocks
Dividend stocks can generate income and grow your wealth, but holding them in taxable accounts means dividends may be taxed at ordinary income rates. Consider holding dividend stocks in a traditional or Roth IRA.
4. Actively managed mutual funds
Actively managed funds can create tax headaches due to high portfolio turnover and capital gains distributions. Consider low-cost index funds and ETFs for a more tax-efficient option.
5. Balanced funds
Balanced funds hold a mix of stocks and bonds, with the bond income being taxable. Portfolio rebalancing could also lead to capital gains for shareholders. Consider holding balanced funds in a tax-advantaged account.
Bottom line
While these investments can be beneficial, holding them in tax-advantaged accounts can help shield them from taxes. Conduct your own research before making investment decisions, and remember that past performance is not indicative of future results.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.