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I have some extra income that I would like to put into mutual funds, instead of leaving it in a 1% interest savings account (best I could find right now). I'm in the United States.

Some background - I have about a year of emergency funds saved, and no debts. I am contributing the max to my IRA each year.

If I buy into some funds via Vanguard for example, what are taxable events? My understanding:

  1. If I were to sell any holdings off.
  2. Any dividends I receive each year.

Are there any other tax or legal things to be aware of before starting this kind of investing? I'm only familiar with investing in the context of retirement accounts,

Thanks

  • What country are you located? – Pete B. Oct 31 '16 at 17:16
  • @PeteB forgot that key info, the US – user3203425 Oct 31 '16 at 17:24
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If you buy and hold a mutual fund there are three areas on which you are subject to taxes:

  • Dividends
  • Short-term capital gains
  • Long-term capital gains

At the risk of being overly political there is often a debate over the marginal rate of for dividends and long-term capital gains. Conservatives are attempting to hold the rate at 15% where progressives are attempting to increase the rate to your top marginal rate. I'll leave the nuances of the argument for another post. The important part is, right now, those are taxed at 15%.

The consensus is that short-term capital gains should be taxed at your top marginal rate. According to the rhetoric having short term capital gains (even if held for 9 months) makes you a "day-trader" and you should be punished.

You will receive a statement from your mutual fund that outlines what amounts are dividend, long and short term capital gains.

You can also be hit with capital gains once you redeem your mutual funds. Depending on the length you held your shares will determine if they are long or short term capital gains.

So there is an added benefit to doing what you are seeking. As long as the current political climate exists, you will pay far less taxes on some portion of what you earn in a mutual fund.

  • Thanks Pete - could you elaborate on the last sentence in your answer? From what I read, interest on a savings rate gets taxed at my federal tax bracket rate. However dividends (currently) get taxed at 15%. So you mean I'm saving money by earning via dividends vs earning via savings account interest? – user3203425 Oct 31 '16 at 17:47
  • Correct. If you earn $100 in dividends, you'll pay $15 in taxes. If you earn that same $100 in interest, you will pay your top marginal rate. – Pete B. Oct 31 '16 at 18:40
  • Re: The disparate tax rates on long and short term capital gains. Some of the thinking is that since gains are taxed in nominal dollars without consideration of inflation, the lower rates on longer term investment offset the taxation on some of the phantom gain that only exists because of the devaluation of the currency. – JohnFx Oct 31 '16 at 23:53
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    You should mention that mutual funds can subject the holder to capital gains taxes (short- or long-term) even when no trades take place, because the fund itself may have to buy and sell assets, and will pass the taxes along to the investors. – BrenBarn Nov 1 '16 at 4:24

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