Navellier Growth: your source for market-beating growth stocks

 

Nothing is certain, they say, except death and taxes. Neither is exactly a pleasant concept. While we can do nothing about one of the two, we can do something to minimize the taxes that we pay. This is especially true when it comes to our investing gains. So I'd like to take a minute to discuss a few tax tips with you–it's very important.

One of the more important taxes to be aware of when investing in stocks is the capital gains tax. This is a tax paid on any asset that is sold at a profit, whether it be a house, a Mickey Mantle rookie card, or as in our case, a stock. In the United States, capital gains taxes are assessed in one of two ways, short or long term. A short-term gain, defined as a gain on an asset held less than a year, is taxed as ordinary income at the taxpayer's regular tax rate. For most investors, this means 35% on short-term gains. However, an asset held for more than a year and sold at a gain is taxed at a much more favorable rate, just 15%. That's one hefty difference!

In 2003, among other tax cuts, not only was the tax rate on capital gains lowered to 15%, so was the tax on dividends from common stocks. Prior to this, dividends were taxed as ordinary income, again at the taxpayer's regular income tax rate. So an investor who has a bond that pays interest of $100 would pay a tax of 35% or more, but a stock investor who received the same $100 as a dividend would pay only 15% in tax. This is a significant advantage and gives us another way to use stocks to lower the taxes we pay on our investment portfolio.

Now if you're like most folks, you're likely thinking, "I'm buying and selling stocks and making a lot of money--who cares about being tax efficient?" Well, oftentimes it's those very folks who are blindsided when it comes time to pay Uncle Sam on April 15th.

Take a look at this scenario

Let's look at exactly how important investing in a tax efficient manner can be. In February of 2007 I recommended Research in Motion (RIMM) to my Blue Chip Growth subscribers. RIMM makes the extraordinarily popular blackberry communication device and we expected great things from the company and the stock. RIMM did not disappoint! A year later we are up 129% in the stock.

If we sold right now, what a great gain that would be. We would pay just 15% tax on our gain. But suppose we weren't so patient with RIMM and decided to sell it last fall when the stock hit $70, we'd have been up 70% in the stock. A nice gain if we sold it, except for the fact that if we sold then, 35% of the gain would have gone to the federal government in the form of short term capital gains tax.

In this example it seems pretty clear cut, but let's consider another scenario. What happens if the stock went down as we waited the required year to hold it? Let's examine more closely.

Let's say Sue bought $10,000 worth of RIMM when I first recommended it. Today, her investment would be worth $24,700. But if Sue sold out today, she'd have to fork over 35% to Uncle Sam–that's over $5,000! But if she waits for the 15% long-term capital gains rate to kick in, the whole game changes. Her tax bill would drop nearly $3,000. In fact, even if RIMM's stock took a sharp 14% drop, as long as she sells at the lower tax rate, she'd still come out ahead. That's how important tax planning can be.

With the exception of my Quantum Growth and Global Growth services, which are my short-term trading services (and even here we suggest using tax deferred accounts such as IRA's to avoid the tax hits from our frequent buying and selling) we look to be as tax efficient as possible. Our objective is to buy the very best stocks and hold them at least one year and a day so as to minimize the amount of tax we pay on our gains. In actual practice over the years, our big gains have come from stocks held for two years or more so that taxes are as little as possible.

So it is really your decision: 15% or 35%? Seems to be an easy choice to me. By focusing on being tax efficient as well as picking the right type of stocks, you can increase your overall returns and the amount of money available to make your financial goals and dreams come to fruition!

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