How to Reduce Capital Gains Taxes

Keeping your taxes low gives you more money to invest.
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When you buy and sell stocks and other investments, you might be required to pay capital gains taxes on the profit you made. Over time, the impact of those taxes can really eat into your returns, so it is a good idea to use investments and strategies designed to reduce your capital gains tax liability. From holding high-flying funds in retirement accounts to using index funds for the bulk of your portfolio, there are a number of ways you can reduce your capital gains taxes without sacrificing return or portfolio performance.

Step 1

Place as much of your portfolio as possible into tax sheltered accounts like IRAs and 401k plans. Buying and selling stocks and mutual funds within these investment vehicles does not trigger a capital gain, since the funds are only taxed when they are withdrawn in retirement.

Step 2

Check the turnover ratio for each mutual fund you are considering. The turnover ratio is a measure of how often the stocks in the fund are bought and sold. The higher the turnover ratio the higher the capital gains it is likely to generate. One sound strategy is to hold high turnover funds in your tax sheltered accounts, while holding index funds in your taxable accounts.

Step 3

Choose index funds for your taxable accounts. Managers of index funds do not try to time the market by constantly buying and selling stocks. The managers of these funds only buy and sell when the makeup of the underlying index changes.

Step 4

Review the capital gains statements you receive each year from your mutual fund holdings. Consider selling the funds that generate the highest capital gains, or buy those funds within a retirement plan instead of a taxable account.

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