Daniel. Or Danielle.
It's Daniel.
Daniel. Dan. Party foul. No location given. We're going to stop answering your questions...
...unless you tell us where you're from.
Just make something up - or else I will.
Where do you think he's from. Los Angeles?
I dunno. Nope. I don't think so. Little Rock, Arkansas. "I have a significant amount of
taxable capital gains in my portfolio. Is there any way to reduce the taxes on my portfolio
so I can modify my investments? Thank you for any advice you can provide." So he's got
a "significant amount of taxable capital gains in my portfolio."
So there's a couple ways you could answer that question, I would say. I'll start with
the first way I can think of...
Well congratulations, you made money. Pay the tax and move on.
(laughs) We can do better than that. So one way we could take this question is, he's talking
about he's got a lot of taxable dividends - in other words, maybe he got into some high
dividend-paying stocks and so - or maybe he's in actively-traded mutual funds.
Oh, you think that's his question?
Well that's one way to answer it. And then the other is, probably what you're thinking,
which is he's got gains in his portfolio.
Okay. Yeah. Both ways. I like your style.
So I'll start with the first one. The first one is when you have investments outside of
retirement, particularly like if it's a mutual fund or index fund. That particular fund is
going to have assets. Stock for example, stock certificates, and those stock certificates
are interest in companies that pay dividends. And those dividends actually come to you and
they typically come to you once a quarter and you have to pay taxes on them, and then
typically there's some buys and sells inside the mutual fund. Those are called capital
gain dividends, and that tends to happen in December. In general, it could be different
but that's most commonly. And so there are certain mutual funds that are tax efficient
and certain ones that are not. And the ones that are tax efficient tend to be more like
index-type funds like the S&P 500 where it's just mirroring an index and so there's not
a lot of trading, buys and sells. And then it's kind of a cross-section of companies,
some or higher dividend stocks some are lower dividend-paying stocks. As opposed to, there
are mutual funds that have high dividend-paying stock companies. And so all the sudden, it's
like even if you don't need the money, even if you're reinvesting that money to buy more
shares, you're paying taxes as you go, which isn't very tax efficient.
Yeah, it's a tax drag.
Right. Yeah. So if that's the question, then it's very simple, you just switch some of
your investments that are generating a lot of dividends and switch to ones that would
generate less dividends, maybe even go to municipal bonds, which is tax-free interest.
There are ways to reduce the income that you actually pay.
Yeah I think you look at the type of fund that you're in. If it's an actively-traded
fund, if it's an actively-managed mutual fund, you're going to see a lot more turnover in
those funds, that will kick out more types of interest and dividends, capital gains that
you'll pay tax on even if you're reinvesting.
Yeah. And worst comes to worst is if you buy into that fund in, let's say early December
and then they have this big capital gain distribution and so you're basically paying tax on, in
essence, everyone else's gain over the last year.
And be careful also with those types of investments because we've seen where the investment actually
went down in value and you still got a tax bill. So just understand what you're holding
outside of retirement accounts to be a little bit more tax sensitive.
Now for those of you that are worried about that, it does work out in the end, because
when you pay tax on this it increases your tax basis so that when you sell that investment,
there'll be less gain.
Yeah. But there are also times too that the mutual fund managers are buying and selling
stocks and they have their own cost basis within the stock, within the fund. And let's
say your mutual fund NAV price is at $20 a share and the market tanks and it goes to
10. You still might have to pay tax on a totally different basis within the fund because they
could have been trading.
They're issuing the capital gains dividends based upon their basis inside. Wow, now you
got really technical. Look at you.
(laughs) Yeah. Right. So it wouldn't work out. It wouldn't even out. Where I think what
you referring to is let's say if I had a dollar dividend and my stock price went down, it's
the same-same.
Yeah. Yeah. I mean in essence you're basically prepaying a tax that you don't necessarily
have to pay to later when you actually sell that investment. So that's one way to answer
the question. The other way, which I think where you went, which is where I went originally
too, which is, maybe inside his non-qualified or non-retirement investments there is significant
gain. He bought some stock at $10,000, now it's worth $20,000, or he bought at $50,000,
now it's worth $200,000 - whatever. And it's like, "gosh, I'd like to take some of these
profits but it's there's a lot of gain in there."
Yeah. It's like, "I don't want to sell this." (laughs) So our advice is always, you want
to make sure that you have the appropriate diversified portfolio given what you're trying
to accomplish and if you have to pay a little bit of tax, so be it. There are strategies
though long-term to reduce some of that bite. Because if I'm just holding on one security,
for those of you that like to buy individual stocks, it's very, very difficult to do any
type of active tax management within it, such as tax loss harvesting. Because if I have
a gain in one stock and if I have a loss in another, I could potentially offset that gain
with that loss. So you have to look at the portfolio and how many investments that you
actually own, how diversified are you, and then there are some active tax strategies
that you could do along the way. So if I sold now and had a tax bill, I still have another
seven months, let's say, in the market. And look at how volatile the market's been. There
could be ways to sell a security at a different price and harvest some of those losses to
offset some of those gains.
Yeah and those losses, we're talking capital losses. So let's say you sold a security or
investment and have a big gain and you did it right now. And as you say, you've got another
seven months in the year. You've got other investments, and let's say in the next seven
months some of those go down in value. You can actually sell one of those, and that capital
loss nets against the capital gain dollar for dollar. A lot of people don't realize
that. A lot of people think you only get to take $3,000. That $3,000 rule is against ordinary
income. But when it's a capital gain versus a capital loss, those offset dollar for dollar.
And in fact if you've got a bunch of capital losses that you haven't been able to use in
the past, they carry forward and you can use those dollar for dollar against the gain.
So that's one strategy, and another one Joe, I think is, we see this when people have a
number of positions but they want to diversify better, maybe they have a lot of individual
securities. And then what we typically do, we kind of put together a little spreadsheet
that shows the amount of the value of each stock versus the amount of the gain. And then
we come up with a percentage and then we do the lowest gain percentages to the highest
gain percentages, and then we just have a running total, and in many cases, a portfolio
- let's say $500,000 of stock, you might be able to sell $300,000 of it and rebalance
and not pay any tax if there's not a lot of gain. Or maybe there's some losses in some
positions, and then maybe that last couple hundred thousand of positions have bigger
gain, then maybe you slowly bleed that out over time. So that would be a strategy as well.
Right. Or you could do the opposite where maybe you have two positions that have large
gains and you say, "I've ridden this pony long enough." Where then maybe you sell those,
diversify a little bit more. And then the rest of the portfolio you kind of take a look
and bleed those out. But here's the problem is that I think we look so often at buying
and selling investments because of fear or greed within the overall marketplace versus
looking at a sophisticated tax strategy to make sure that you're keeping everything that
you possibly can and reducing your tax bill as much as you can.