Investing is a great way to grow savings over time. However, among the key downsides of doing so is that people ideally have to pay taxes on their investment gains. The more taxes a person pays, the less of their returns they are able to keep. Kavan Choksi, however, underlines that with the right strategy it is possible for people to cut down the amount of taxes they have to pay on investments.
Kavan Choksi sheds light on certain tax-efficient investment
An unfortunate truth about earning an investment income is that the investor would never be able to avoid taxes altogether. The government would always get their cut one way or another. However, how much the government will charge an investor relies majorly on what investments they select and how long they are held. There are certain investments that are not subject to taxation. Investments in particularly tax advantaged retirement accounts shall also be under tax protection.
Here are a few options an investor can go for to minimize their taxes:
- Municipal Bonds: These bonds are issued by the local governments, and tend to be used for funding diverse projects, like building schools and improving roads. As one chooses to invest in a municipal bond, they shall basically be loaning money to the government. The investor shall be guaranteed to enjoy a rate of return in the form of interest payments from the bond. These interest payments shall be exempt from federal taxes. In specific cases, tax exemption might also apply to any local or state taxes on interest earnings. There is a very low risk of default in municipal bonds, and their ability to generate consistent income on a tax-free basis makes them a good addition to a fixed-income portfolio.
- Tax-exempt mutual funds: A mutual fund is basically a collection of securities. They might comprise wholly of bonds or stocks, or feature a combination of two. The fund either tracks an index or is managed by professionals, providing the chance for hands-off investing. There are particular mutual funds that enjoy tax-exempt status. Hence, investors would not have to pay taxes on the returns delivered by those funds. A tax-exempt mutual fund might hold municipal bonds and other government securities. Such funds are able to provide a range of tax benefits, in addition to simplified diversification across multiple types of government securities. Prior to investing, one needs to consider how much returns a tax-exempt fund might offer. They also need to check the expense ratio, to see to it that they are not losing too much management fees.
- Exempt Exchange-Traded Funds (ETFs): While being similar to mutual funds, ETFs trade on the exchange like a stock. A number of ETFs follow a passive management approach. This basically means that the assets within the fund do not turn over as often as they should have with an actively managed fund. A lot of ETFs simply track an index instead of having a fund manager to select securities. Much like mutual funds, ETFs might also be municipal bond-focused, and hence enjoy the same tax-exempt benefit.
Kavan Choksi mentions that being a tax-efficient investor can pay huge dividends down the line, especially as an investor retires. By limiting their tax spending, investors would be able to maximize their financial potential when they need it most.