Buying and selling stocks, for the wise investor, can be an easy way to make money multiply. But the wise investor knows that it's not as simple as day-to-day or week-to-week gambling. You might hit a homerun on a stock that soars twenty percent in a month and, knowing the volatility of the market, want to sell it before its price starts dropping.
Congratulations, you've just made a twenty percent return on your investment. Why are the wise investors laughing, then?
You hear a murmur among the laughter: "capital gains tax." The word "tax" drops like a weight in your stomach. Yes, a tax on your winnings. They are, after all, a form of income.
What is capital gains tax and how can you reduce it?
What is capital gains tax and how does a wise investor factor into into their investing strategy?
The simple answer is that they make long-term investments. We all want to materialize our gains quickly but doing so can hurt them more than you might expect.
Short-term capital gains tax affects short-term investments—buying a stock and selling it within one year. The important word here is "selling": you only realize a gain or a loss when you sell the stock. Therefore, capital gains tax only comes into play when you sell a winning stock (capital gains tax affects all kinds of "capital assets").
The short-term capital gains tax rates (investments held for at least one year and one day) are significantly higher than the long-term. Short-term rates equal the normal income tax rate. The rates depend on your tax bracket, but at every level, the long-term rate is lower than the short-term rate.
Those in the 10% and 15% income tax brackets will face 10% and 15% short-term capital gains taxes, but 0% long-term rates. In the higher brackets, though both rates increase, investors will still save 10% or more by holding stocks for more than a year.
The simple solution, therefore, is to invest with long-term goals in mind.
An investor who needs to sell a stock before a year is up can try to offset some of the gains by also selling a stock or stocks suffering losses. Capital gains tax only affects the net capital gain for the year: this is the total gains after all sales.
If you sell one stock at a $2,000 gain and another at a $1,000 loss, you'll cut your net gains in half and reduce the amount on which you can be taxed. It sounds like simply losing money in a different way, and it is. But it eliminates part of a loss on stock while reducing the tax at the same time, minimizing the overall loss.
The bottom line is that you'll have to pay up somehow. Maximizing returns involves more than simply finding the golden stock. The wise investor understands the differences between short-term and long-term investing, factors capital gains tax into their plan and, when circumstances call for a short-term sale, uses a strategy that realizes other losses to offset the gains and reduce the taxable amount.
When you take out a loan for a car, charge something to your credit card, or get a personal line of credit, there is going to be an interest rate that applies to your loan.
A lot of different factors go into what you will be charged, including your own personal credit score. But even those with flawless credit still see a minimum charge that they can't get around. That all goes back to the Federal Funds Rate.
One thing consumers rarely realize is that all of our banks are lending money to each other every night. Banks are legally required to maintain a certain percentage of their deposits in non-interest-bearing accounts at the Federal Reserve to ensure they have enough money to cover any withdrawals that may unexpectedly come up. However, deposits can fluctuate and it's very common for some banks to exceed the requirement on certain days while some fall short. In cases like this, banks actually lend each other money to ensure they meet the minimum balance. It's a bit hard to imagine these multibillion-dollar financial institutions needing to borrow money to tide them over for a bit, but it happens every single night at the Federal Reserve. It's also a nice deal for those with balances above the reserve balance requirement to earn a bit of money with cash that would normally just be sitting there.
The Federal Reserve
The exact interest rate the banks will charge each other is a matter of negotiation between them, but the Federal Open Market Committee (FOMC) (the arm of the Federal Reserve that sets monetary policy) meets eight times a year to set a target rate. They evaluate a multitude of economic indicators including unemployment, inflation, and consumer confidence to decide the best rate to keep the country in business. The weighted average of all interest rates across these interbank loans is the effective federal funds rate.
This rate has a huge impact on the economy overall as well as your personal finances. The federal funds rate is essentially the cheapest money available to a bank and that feeds into all of the other loans they make. Banks will add a slight upcharge to the rate set by the Fed to determine what is the lowest interest that they will announce for their most creditworthy customers, also known as the prime rate. If you have a variable interest rate loan (very common with credit cards and some student loans), it's likely that the interest rate you pay is a set percentage on top of that prime rate that your lender is paying. That's why in times of low interest rates (it was set at 0% during the Great Recession), a lot of borrowers should go for fixed interest rate loans that won't increase. However, if the federal funds rate was relatively high (it went up to 20% in the early 1980's), a variable interest rate loan may be a better decision as you would be charged less interest should the rate drop without the need to refinance.
The federal funds rate also has a major impact on your investment portfolio. The stock market reacts very strongly to any changes in interest rates from the Federal Reserve, as a lower rate makes it cheaper for companies to borrow and reinvest while a higher rate may restrict capital and slow short-term growth. If you have a significant portion of your investments in equities, a small change in the federal funds rate can have a large impact on your net worth.
Whether you're leaving a job involuntarily, departing for something new, or just want to prepare for the unknown, it is smart to understand all your options regarding your 401k.
Frugal gifting often gets a bad reputation. However, this shopping method does not make you cheap — it makes you practical. Frugal gifts often avoid waste and overspending and can be just as meaningful (if not more so) as any other present.
With the National Retail Federation predicting each consumer this holiday season to spend upwards of $1,000 on holiday gifts amidst an economic recession —this year might be the perfect time to reconsider your spending budget. We've formulated the ultimate list of frugal gift-giving ideas to get you started.