Start Me Up
Well, we certainly had ourselves a scary little Christmas, with the S&P ending down 6% for December, after the much hoped for year-end rally never materialized. But now we’re off to the races in 2023 and investors are collectively holding their breath, and rightfully so, since 2022 included some heinous outflows from major asset classes. Bonds in particular saw outflows of $375 billion, the largest amount ever and the first year of outflows since 2013.
As we review and revisit all of the outlooks for 2023, I propose that we not look at the year in terms of the first half versus second half, but rather start out just taking it one month or one quarter at a time. That may be counter-intuitive for long-term investors and the typical tone to my commentary, but I think it’s safe to say that investors’ emotions have been running high for over a year and that naturally makes us hyper-vigilant and more short-term oriented.
Under Jay’s Thumb
Since the next Fed statement isn’t until Feb 1, at least January will be free from the anticipation and subsequent reaction to every word that comes out of Jay Powell’s mouth. But make no mistake, markets are and will continue to be, under Jay’s thumb.
And so will technology stocks until there’s some shift in the wind. With the five largest components of the S&P still making up nearly 20% of the index and including Apple, Microsoft, Google, and Amazon, big tech names continue to dominate the conversation and have become a meaningful source of polarizing opinions.
The temptation to draw parallels to prior rate hiking cycles, prior recessions, or prior inflation regimes is strong. But in a time when we have a Fed balance sheet larger than ever before, and an FOMC committed to not repeating previous mistakes, those historical comparisons are likely less predictive.
Despite January’s lack of Fed events, the first quarter of this year will have plenty. Current expectations include a 25-basis-point hike in February and another 25 in March. If we make it through both of those, I’m not expecting there to be further hikes, which means we would know by the end of the first quarter if the Fed is done raising rates.
But that’s not victory. It just means we move onto the next leg of the journey and try to decipher how long rates will stay that high and continue to pressure financial assets.
Can’t Always Get What We Want
I want inflation to come down without having to reduce consumer spending, I want people to keep their well-paying jobs and enjoy wage inflation without pressuring corporate profits, and I want the yield curve to un-invert while stocks rise and erase our losses from 2022.
And I say to myself, “Fat chance, Liz.”
But as the song goes, “…if you try sometimes you just might find, you get what you need.” What we need is to get closer to finding balance in prices. It’s been messy already, and it’s likely to stay messy and hurt the economy more before it’s done. I’m talking particularly about the labor market and home prices, and I expect the December data to start showing this decline more convincingly.
My expectations for market action in January are admittedly not rosy. But if we start to see serious declines in inflation data and confirmation from other parts of the economy that the imbalances are slowly working their way out…I’ll find some reasons to smell the roses.
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Communication of SoFi Wealth LLC an SEC Registered Investment Adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at adviserinfo. Liz Young is a Registered Representative of SoFi Securities and Investment Advisor Representative of SoFi Wealth. Her ADV 2B is available at sofi.
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Investment tax rules every investor should know
Investing can feel like a steep learning curve. In addition to having a clear grasp of types of investment vehicles available and understanding the role investments play in overall financial strategy, it’s a good idea to understand how taxes may affect your investments. Knowing tax implications of various investment vehicles and investment decisions can help an investor tailor their strategy and end up with fewer headaches at tax time.
Related: What is leverage?
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Tax requirements for investments can be complicated, and it can be helpful for investors to work with a professional to see how taxes might impact a return on their investment. Doing so might also help ensure that investors aren’t overlooking anything as they explore avenues for favorable tax treatments.
That said, it’s always helpful to enter into any discussion with some solid background information on when and how investments are taxed. Typically, investments are taxed at one or more of these three times:
- When you sell an asset for a profit. This profit is called capital gains—the difference between what you bought an investment for and what you sold it for. Capital gains taxes are typically only triggered when you sell an asset; otherwise, any gain is an “unrealized gain” and is not taxed.
- When you receive money from your investments. This may be in the form of dividends or interest.
- When all profits from investments are considered under an umbrella. This view may trigger a tax called the Net Investment Income Tax (NIIT).
- In the following sections, we delve deeper into each of these situations that can lead to taxes on investments.
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Capital gains are the profits an investor makes from the purchase price to the sale price of an asset. Capital gains taxes are triggered when an asset is sold (or in the case of qualified dividends, which is explained further in the next section). Any growth or loss before a sale is called an unrealized gain or loss, and is not taxed.
The opposite of a capital gain is a capital loss. This occurs when an investor sells an asset at a lower price than purchased. Why would an investor trigger a capital loss? That depends on the investor. Sometimes, an investor needs to sell an asset at a suboptimal time because they need the cash.
At other times, an investor may sell “losing” assets at the same time they sell assets that have gained as a way to minimize their overall tax bill, by using a strategy called tax-loss harvesting. This strategy allows investors to “balance” any gains by deliberately selling profits at a loss, which, according to IRS rules, can be carried over through subsequent tax years.
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There are two types of capital gains, depending on how long you have held an asset:
- Short-term capital gains. This is a tax on assets held less than a year, taxed at the investor’s ordinary income tax rate.
- Long-term capital gains. This is a tax on assets held longer than a year, taxed at the capital-gains tax rate. This rate is lower than ordinary income tax. For 2021, as per the IRS , the long-term capital gains tax was $0 for individuals with taxable income less than $80,0000 and no more than 15% for most individuals (for those making more than $496,600, the rate jumps to 20%).
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Dividends are distributions that a corporation, S-corp, trust or other entity taxable as a corporation may pay to investors. Not all companies pay dividends, but those that do typically pay investors in cash, out of the corporation’s profits or earnings. In some cases, dividends are paid in stock or other assets.
Dividends that are part of tax-advantaged investment vehicles are not taxed.
Generally, taxpayers will receive a form 1099-DIV from a corporation that paid dividends if they receive more than $10 in dividends over a tax year. All other dividends are either ordinary or qualified:
- Ordinary dividends are taxed at the investor’s income tax rate.
- Qualified dividends are taxed at the lower capital-gains rate.
In order for a dividend to be considered “qualified” and be taxed at the capital gains rate, an investor must have held the stock for more than 60 days in the 121-day period that begins 60 days before the ex-dividend date. (Additionally, said dividends must be paid by a U.S. corporation or qualified foreign corporation, and must be an ordinary dividend, as opposed to capital gains distributions or dividends from tax-exempt organizations.)
Both ordinary dividends and interest income on investments are taxed at the investors regular income rate. Interest may come from brokerage accounts, or assets such as mutual funds and bonds. There are exceptions to interest taxes based on type of asset. For example, municipal bonds may be exempt from taxes on interest if they come from the state in which you reside.
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Net investment income tax (NIIT) is a flat 3.8% surtax levied on investment income for taxpayers above a certain income threshold. The NIIT is also called the “Medicare tax” and, as per the IRS , applies to all investment income including, but not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and income from businesses involved in trading of financial instruments or commodities.
In 2021, NIIT applies to individuals with an adjusted gross income (AGI) over $200,000 for single filers and $250,000 for married couples filing jointly. For taxpayers over the threshold, NIIT is applied to the lesser of the amount the taxpayer’s AGI exceeds the threshold or their total net investment income.
For example, consider a couple filing jointly who makes $200,000 in wages and has a NIIT of $60,000 across all investments in a single tax year. This brings their AGI to $260,000—$10,000 over the AGI threshold. This would mean the taxpayer would owe tax on $10,000. To calculate the exact amount of tax, the couple would take 3.8% of $10,000, or $380.
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Certain types of investments may be exempt from tax implications if the money is used for certain purposes. These investment vehicles are called “tax-sheltered” vehicles and apply to certain types of investments that are earmarked for certain uses, such as retirement or education.
There are two types of tax-sheltered accounts:
- Tax-deferred accounts. These are accounts in which money is contributed pre-tax and grows tax-free, but taxes are taken out when money is withdrawn. For example, a 401(k) retirement account grows tax-free until you withdraw money, at which point it is taxed.
- Tax-exempt accounts. These are accounts—such as a Roth 401(k) or Roth IRA, or a 529 plan—in which money can be taken out tax-free if the funds are taken out according to qualifications. For example, money in a Roth account is not taxed upon withdrawal in retirement.
Beyond investing in tax-sheltered accounts, investors may also choose to research or speak with a professional about tax-efficient investing strategies. These are ways to calibrate a portfolio that may help minimize tax hits, grow wealth, and ensure that key portfolio goals—such as ample savings for retirement or ensuring adequate liquidity —are met.
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Dividends, interest, and gains can add up, which is why it’s important for a taxpayer to be mindful of investment taxes not only at tax time, but throughout the year. Understanding the implications of sales and keeping capital gains taxes in mind when planning sales can help investors make tax-smart decisions.
Because there are so many different rules regarding taxes, some investors find it helpful to work with a tax pro to ensure they’re not overlooking anything in their portfolio. Tax law also varies by state, and a tax pro should be able to tailor strategy to a taxpayer’s home state to minimize liability.
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originally appeared on SoFi.comand was
syndicated by MediaFeed.org.
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