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Trading Stocks and Taxes
Question: I'm a weekly listener via podcasts and thank you for all the good advice. So the question: My co-worker mentioned that I could trade my stocks in an IRA and not have to pay capital gains taxes with this type of account. Currently, I trade within a taxable account so my gains are taxed. Is there any drawbacks with trading stocks within an IRA and what is the best way to learn about the process. Thanks a bunch! David
Question: Your co-worker is right. You don't pay any capital gains taxes on trades within an IRA. If it is a traditional Individual Retirement Account, you will pay ordinary income taxes on the money when you withdraw it during your Golden Years.
Here's the main drawback to trading stocks in an IRA. When it comes to saving for the long haul there's no evidence that all that trading activity will line your pockets. There is abundant evidence that a disciplined, long-term approach with minimal trading and low fees will increase the odds that you'll reach your long-run financial goals. So, my response is restrain your trading impulses in an IRA--it's a hazardous habit for long-term wealth accumulation.
That said, I don't want to be a spoilsport. Picking stocks is fun. You get to match wits in the most competitive market in the world. But I think the tax code encourages you to do trades in a taxable account. Here's why: Let's say you make some unprofitable trades. The market goes against you. Uncle Sam limits your losses through the tax code. Now, let's say you have made some smart moves and share prices have moved up. You still get to decide when to trigger the capital gains tax rate. You could sell tomorrow--or 30 years from now. That's a powerful tax shelter. (There are a few complicated exceptions where you can take a tax loss on an investment in an IRA, but they're the exception, not the rule.)
One more point: Bill Gross, the investment guru and founder of the mutual fund giant Pimco, once suggested that investors play with no more than 10% of their portfolio. He reasoned that it's just enough to make a difference if you win on the upside, and not enough to make a difference if you are wrong on the downside. I've always found that sound advice. This way you're not putting your standard of living in retirement at risk.
With all due respect to Bill Gross, playing with 10% is a fool's game. Bonds do not deliver a return that covers inflation. (Email me Chris and I will give you data.) Only stocks cover inflation and in fact hard resources such as gold, oil, etc. That is why gas is so much more expensive these days. The Arabs price oil in US$ so if you look at gold, gas has not gone up in price but the US$ has gone down in value. The heuristic is subtract your age from 120 to tell you what percentage to put in equities. In fact I question that as people are living much longer so perhaps they should put a higher percentage at risk to be assured that they will not outlive their money. Now most people use asset allocation for their portfolios; hence some % in equities, some in bonds, some in gold stocks, etc etc. Just don't lose a big chunk within the first three years of retirement and don't run out of money at the end by being too conservative.
