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September 11, 2010


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I agree with you that you shouldn't buy and sell based only on taxes. I think many times novice investors who try and game taxes end up reducing their net returns by buying and selling at the wrong times or taking on too much risk.

It's hard enough for people to invest on their own for gains. But I do agree that many of the suggestions, if done right, can help (if done right is the key). #1 is probably not worth it for a lot of "regular" people because it puts their financial future in the hands of only a few companies (unless they have a very big portfolio). The "value" of the hightened risk might offset the "value" of any tax benefit you'll be able to gain... I'm a big ETF guy for novice investors.

Two things to add:

1. Mutual funds have what is called a "captial gains distribution". This is taxed at the capital gains rate and not the ordinary income rate. Yes, you are at the mercy as to when and what you get, but at least it is at the lower rate. Also, if you invest in a mutual fund right before its distribution (usually in December), you will get some of your money back that you invested in distributions and you will immediately have to pay taxes on that money. Some people feel that it is better to wait until after the distribution to invest in a mutual fund, but everybody's situation is different.

2. Muni funds and bonds usually have a lower yield than taxables, so take that into account before investing. If you are in a lower tax bracket, you might be better off investing in a taxable bond because the additional yield might offset the additional taxes. Again, depends upon your situation.

I agree, it's a mistake to make your decisions based on the tax penalties but it does guide my decisions. These are great points to consider even if trying to delay a sale until the next year is sometimes impractical. It does help to offset the penalties by dumping the low performers. Thanks for a great post!

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