Taxable accounts are an important part of investing for the long-term. They help investors diversify their tax strategy and provide flexibility in comparison to non-taxable accounts. However, understanding taxable accounts and what to put in taxable accounts can be confusing, so today’s post aims to clear that up. Today’s post will go over the basics of taxable accounts: what is a taxable account, why invest in a taxable account, and what to buy for your taxable account.
What is a taxable account?
Think of a taxable account as a general account that you open with any brokerage. For newbies to investing in the stock market, a good rule of thumb on determining whether your account is taxable account is to take a look and see if there are any weird letters or numbers before the account, like 401(k), ROTH, etc. If you don’t see anything like that associated with your account, chances are it’s a taxable account.
Why invest in taxable accounts?
- Flexibility – tax advantaged or non-taxable accounts like 401(k), IRA, ROTH IRA do provide you the advantage of growing your investments tax free, however they do so at the cost of not having full access to your funds. When I say full access, I mean that if you choose to withdraw from your non-taxable accounts, you will incur a penalty of sort depending on the account. The advantage of keeping some investments in a taxable account is you have the flexibility at any time to take your money out for any reason.
- Tax efficiency – taxable accounts give you a chance to grow your wealth in a way that can greatly minimize your tax bill by choosing tax-efficient investments. So the question is….
What to buy?
Here are a few investments to consider when investing in taxable accounts
- Low Expense ETF’s – look for low expense ETF’s. Vanguard ETF’s are usually a good spot to find these kinds of funds. Think of ETF expenses as cost of ownership. The lower the cost of ownership, the more money you get to keep at the end of the day. Look to funds like VOO (S&P) and VTI (Total Stock Market).
- Municipal Bonds – municipal bonds are a good choice because you won’t pay federal tax on the dividends paid by the municipal bonds. Look to funds like MUB.
- Buy and Hold Stocks – blue chip stocks. Think of big names that have products that would be relatively hard to replace or beat. This brings to mind names like Kellog (K), Coca-Cola (KO), IBM (IBM), AT&T (T). The idea being here is that you would buy these stocks and not let them go for a long time, thus avoiding tax on capital gains from the selling of the stocks. Another thought – you may want to also look at stocks that don’t pay substantial dividend but that you expect to go up in pure stock price. This way you can avoid paying taxes on dividends received. Think of names like Tesla (TSLA), Facebook (FB), Google (GOOGL).
What to avoid?
- Actively managed mutual funds – since actively managed funds trade more frequently, there is more of a chance of them booking gains (sell at a profit) that can show up on your tax bill.
- REITs – REITs are great investments, but they often pay large dividends. These dividends will be taxed if kept in a taxable account. It’s better to place your REIT investments in a non-taxable account like a ROTH IRA or Traditional IRA.
- Illiquid Investments – one of the big advantages of taxable accounts is freedom of access to your investments, so make sure you don’t negate that advantage by investing in illiquid investments. Looks for stocks or funds that are relatively popular, i.e. have a lot of “volume” in terms of trades per day. This way if you get into a position where you have to sell, you can be pretty confident you’ll be able to find a buyer in the market relatively fast.