money The tax implications of frequent trading
Amy Richardson, Schwab Intelligent Portfolios Financial Planner joins Yahoo Finance Live to discuss tax implications of frequent trading and breaks down how Americans can be smarter about investing for the following tax season.
Video Transcript
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- Welcome back to Yahoo Finance Live. Yeah, it's tax time. So are you one of those new investors this year, new traders? There were a lot of them in 2020, actually. 60% of brokerage accounts opened were opened by first-time investors at Schwab last year, where they were younger investors-- Gen X, millennials, Gen Z. So they might not have been through this thing before where you have to go and actually pay some taxes on some of your winners. Or maybe you have losers. How do you go about doing all of that? Let's bring in Amy Richardson, Schwab Intelligent Portfolios financial planner. So Amy, what's the biggest mistake that you see first-time traders make when it comes to tax time?
AMY RICHARDSON: Absolutely. One of the biggest things that we spend time educating our clients on are the tax implications when it comes to investing. So when you sell an asset or an investment security for more than you paid for it, you make a profit, it triggers what we call a capital gain. And the capital gain signifies that you're going to owe some taxes this year on it that are going to be due when you file.
And one thing to note here is there's really two types of capital gains. We have a short-term capital gain, which is something that signifies you owned that security for less than a year. And those rates are subject to ordinary income tax rates. And then we have something that's a long-term capital gain, meaning you held that security for more than one year. And it has more favorable tax treatment at the federal level, with the highest tax rate coming in at 20%.
- Now, I want to ask about the people that lost money. So there were a lot of people who maybe tried to get into the GameStop action a little bit too late. They took some pretty harsh losses. If they sold, what's the best way to approach that, Amy?
AMY RICHARDSON: Absolutely. We know that not every investment is going to be a winner, but I have some good news. There is some silver lining in this for our investors. And it is in the benefit of what we call tax loss harvesting. And really, what that means is it seeks to reduce an investor's current tax burden, and also provides investors with a convenient way to improve their overall long-term total return net of taxes. And really, tax loss harvesting is the process of selling a security for a loss, and taking those losses somewhat-- I use the term banking it, if you will, and then using those losses to offset other gains that you may have in that year. And so what it does is really, again, it reduces that overall net tax burden for the year.
The other thing that tax loss harvesting can do is, when you sell that security for a loss, if you simultaneously buy a similar security, you're able to stay invested in the market, but also, again, use that loss to offset future gains. And what we really like about that is, again, you are staying invested for the long term, hopefully working towards achieving your goals, rather than trying to get in and out of the market and timing it.
- So I think most people are familiar with a lot of the retirement benefits that are out there. You know, your 401(k) or your Roth. But what about the types of investments? Because I think sometimes we've lost a little bit track of this, as everyone's just driven into ETFs. But in terms of types of investments, what are the most beneficial for taxes?
AMY RICHARDSON: Absolutely. So one example is something like an exchange traded fund or an index fund. And these are more tax-efficient vehicles because of the structure that it's different than a mutual fund. And so when you choose to invest in an ETF or an index fund, they are passively managed, where they really just try to track an index. And because of the securities the index fund are not traded as frequently as, say, a mutual fund, they are going to generate lower capital gains distributions, which therefore create a more tax-efficient investment for you, the investor.
The other thing is location, right? So we have our taxable accounts, or your brokerage account, and then you've got your IRAs and your qualified accounts. And so making sure that you are putting the right investments in the right accounts can be really beneficial. So something like a dividend-paying stock or something that you're going to trade a lot in, probably better in a retirement vehicle because you aren't paying taxes on those gains each year. They're tax-deferred. And then something like an ETF or something that's more passively tracking an index is better in a taxable account, where it's not kicking off those capital gains, things like interest and dividends.
- And as far as strategy, it's important to remind all of our viewers that the tax day for federal taxes has been extended to May 17th. So you can think a little bit longer about these strategies. But again, Amy Richardson, Schwab Intelligent Portfolios financial planner, thanks so much for joining us today.
