Individual Stocks and Exchange-Traded Funds

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Individual Stocks and Exchange-Traded Funds

Stocks

One of the best ways to minimize taxes on your investments is to buy stocks. Unlike the typical fund investor, you could pay nothing in taxes. You can’t beat that.

Well, you will still pay capital gains taxes when you sell a stock, but if you hold your stocks for at least a year, you’ll pay just a relatively lower long-term capital-gains tax rate. And by choosing when you sell, you control when you pay the taxes.

To be a tax-free stock investor, avoid the two things that force funds to make taxable distributions to their shareholders: dividend-paying stocks and selling. Shun dividend-paying stocks because the dividends you get are taxed. And if you don’t sell, you won’t pay capital gains taxes.

Exchange-traded funds

Exchange-traded funds (ETFs) are generally index funds that trade like stocks. For example, SPDRs (SPY) track the S&P 500 Index. Investors buy those shares on the American Stock Exchange (aka the NYSE MKT).

Unlike mutual funds, which always pass capital gains taxes to their shareholders, ETFs only generate taxes by owning dividend-paying stocks or by changing their holdings to reflect changes in their indexes. To minimize your tax bill, use ETFs that track large-company indexes, which change infrequently. Other indexes, such as those tracking small and midsize companies, change more frequently, and that means tax bills for shareholders.