A quick overview on taxation of stocks, mututal funds, and ETFs
Under normal circumstances (in a “taxable account”), you pay taxes at two different events:
A buy and hold investor of broad-based market funds (which you should do; see Bogleheads’ discussion on asset allocation) is generally going to be most concerned with dividend taxation.
Generally speaking, dividends are taxed at long-term cap gains rates (see Selling-Stock section below).
This tax can be quite large:
Historically, the stock market has a 2% dividend yield (meaning each year, you receive 2% of your portfolio value in dividends). Assuming you reinvest these dividends, a ~30% tax is akin to paying a “fee” of ----%/year. (2% * ----%). That small number adds up over time:
When you sell stock (including mutual funds, exchange-traded funds (ETFs)), etc. at a price higher than what you purchased it at, you pay “capital gains tax” on the difference (the “capital gain”) between the sales price and purchase price (“basis”).
If you’ve held the stock for a year, you pay long-term cap gain tax rates (less than a year, you pay higher, “ordinary” rates) on the gain. As discussed in the dividends section, your tax rate is ----%
In practice, we don’t discuss the logistics of selling stock much as:
Subtle notes
In both tax-deferred (IRAs, 401(k), etc.) and tax-free (Roth IRAs, Roth 401ks, 529, HSA, etc.) accounts, all investment transactions are tax-free. So:
These tax-advantaged accounts are incredibly valuable because of the avoidance of these (especially dividends) taxes. See how much a Roth is worth to you!