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One of the things we often forget about when making investment decisions is how such decisions will affect our taxes. However, it is important to consider the tax implications of investments that you make. One of the advantages that index funds have over actively managed mutual funds is that there is lower turnover that equates with lower taxes. The Oblivious Investor describes how this works in mutual funds (remember that index funds are types of mutual funds):

With mutual funds (as opposed to, say, shares of individual stocks), you don’t pay taxes only when you sell the fund. You pay taxes each year on your share of the capital gains realized within the fund’s portfolio.

With portfolio turnover in actively managed funds averaging roughly 100% per year, a great deal of the gains end up being short-term capital gains. Because STCGs are taxed at your ordinary income tax rate (as opposed to LTCGs which are taxed at a maximum rate of 15%), investors in actively managed funds end up paying more in taxes than they would with a fund that holds onto its investments for longer periods of time.

This means that you have better tax efficiency with index funds. This is extremely helpful if you are interested in keeping more of your money in your pocket. Use a tax-advantaged retirement account, and you receive these benefits to an even greater degree.

ETFs and tax efficiency

Even though they aren’t mutual funds, ETFs also have some helpful tax advantages. The Oblivious Investor points out that because of how ETFs are created, they normally distribute less frequent capital gains (and smaller gains) to shareholders. This means that you pay less in taxes.

When comparing different investment options, consider taxes as part of your costs. Just as administrative fees and loads are part of the equation, what you pay in taxes should also be considered. If you neglect to factor in taxes, you could be rather unpleasantly surprised.

Disclaimer: I am not an investment professional. Nothing in this piece or on this Web site should be construed as investment advice. Before making investment decisions, do your own research and/or consult with an investment professional. All investment comes with the risk of loss. You are responsible for your own investment decisions and any loss that may result from your decisions.

The stock market is closed today in observance of the 4th of July holiday. The 4th isn’t until tomorrow, of course, but we like to observe holidays by closing things down. And perhaps that is just as well. After yesterday’s 223-point disaster for the Dow, it’s probably a good time for a break. Perhaps the long holiday weekend will perk up investors enough that they will be ready to make a credible rally attempt on Monday.

So, while we have no new stock market news today, I thought it would be a good time for reflection. As always, our holidays and observations are often lost in celebrations that tend to leave us forgetful of why we are celebrating in the first place. This is a good time to think about the beginnings of our nation, and to consider what we are doing today to make it better. Most of us citizens will probably never put our lives on the line for our ideals. (Military servicemembers do it all the time, however, and for that the rest of us should be grateful.) However, there are other things we can do to be good citizens. And we should try to be good citizens.

What “patriotic” and “good citizenship” mean are subjective. To me, it means being informed, trying to live a good life, being involved in the community in some way, exercising my rights and teaching my son to be a good citizen. To you, it might mean something else entirely. However, it is a good time to reflect on what you think good citizenship entails, and then try to make a plan to live out your idea.

So, take a minute to reflect on what made those who came before good citizens and consider emulating some of their qualities. It’s the perfect time for it.

Happy 4th of July!

Opening an IRA can save you a few bucks on your tax return, and although the year ended in December, the deadline for opening an IRA is actually by Tax Day.

Roth IRA Contribution Limits

The maximum contribution limits are the same for both Roth and traditional IRAs.  In 2006 and 2007, the standard contribution maximum to a Roth IRA is $4,000.  In 2008 and 2009, the contribution limit moves up to $5,000.

If you reach age 50 or older in a calendar year, then you’re entitled to take a catch up contribution.  In the years 2006 through 2009 the catch up contribution limit is $1,000.  However, because the standard contributions are different in 2006 and 2007, you can contribute up to $4,000 + $1,000 or $5,000, while in 2008 and 2009 you can contribute up to $5,000 + $1,000 or $6,000.

You can open up an IRA at http://mystockfund.banks.com and if this sounds like enough work for one day, go ahead and file a tax extension and wait until October.

The best way to file a tax extension online is by going to 1040.com and fill out a few secure online forms. It will give you an estimate on taxes owed, and provide you with printable vouchers if needed. extension.1040.com also offers software for preparing and efiling your return, so when you are ready to revisit your taxes, you won’t need to look for another service provider.