The tax code favors the long-term investor.
A brief summary on how long-term holding periods can allow people to keep more of their gains.
When it comes to investing, most people, especially myself, preaches a long-term mindset. Diversified funds offering broad based exposure to many asset classes is usually the approach for many investors.
I have framed the idea of being a long-term investor many ways. Today, I will try to make that point again in another light.
Don’t worry. I’m not writing a novel this week. This will be pretty straight forward.
Most people are aware that long-term capital gains are more favorably taxed than short-term capital gains. This will only impact assets held outside of tax-advantaged accounts… think a taxable brokerage account.
Here is a quick overview on the differences between short and long-term capital gains:
Short-term capital gains -> realizing gains on a position held for less than one year
Long-term capital gains -> realizing gains on a position held for more than one year
Short-term capital gains tax -> taxed as ordinary income (think marginal tax rate)
Long-term capital gains tax -> 0%, 15%, 20%
Each type of capital gain can subject someone to the Net Investment Income Tax which impacts investment income (dividends, interest, capital gains, etc.) when an individual’s MAGI is above $200,000 or a couple’s income is above $250,000. This would be an additional 3.8%!
So, to further the argument in favor of investing for the long-term rather than the short-term, we can use an example.
Assume we have an individual with MAGI of $260,000. This would place them in the 35% marginal bracket.
Any short-term gains would be taxed at 35%, while any long term gains would be subject to a preferential 15% tax rate.
In either case, whether short or long-term, the gain will be subject to the NIIT, an additional 3.8%.
So, given we are not using any state taxes in this example, the short-term effective tax rate increases to 38.8% and the long-term effective tax rate increases to 18.8%.
No matter what amount of money the individual started with, in order to reach an after-tax gain of $10,000, the difference between long-term and short-term is substantial.
Before tax long-term capital gain: $12,315
Before tax short-term capital gain: $16,340
This is a HUGE difference! In order to net the same after-tax gain, the short-term trade had to earn an additional $4,025!
I hope this example serves as some additional encouragement to those that have a long-term mindset with their investments. And for those who do not, maybe this will change your mind.
It is very clear to me that the tax code favors the long-term investor.
This is for informational purposes only and is not intended as legal or investment advice or a recommendation of any particular security or strategy. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Opinions expressed in this commentary reflect subjective judgments of the author based on conditions at the time of publication and are subject to change without notice. Past performance is not indicative of future results.