The Newbie Syndrome
Unfortunately, I see this in the Stock Investing groups on Facebook… someone (mostly youngish) decide s/he wants to buy stocks and make a lot of money… and maybe they have $500 to spare. I agree with one person who said just keep your money in case of emergency, and another said to have at least 3 months of your salary saved up just in case. These are good ideas and I think the point to get across is that if you are going to invest/trade in the stock market, you need to have funds that you are not likely to see for several months to a year (aside from day and swing trading, but that’s another story altogether).
That Dreaded Capital Gains Tax…
If you buy and sell a stock before 1 year and 1 day, you will be taxed on whatever gains you made from that investment. If you sell a stock after a year and a day? Your capital gains tax will be significantly lower (i.e. not the full amount of tax for your tax bracket). At least that is how I understand it.
In a cash or margin account, you WILL be taxed for the full amount if you buy and sell stocks within a year, and many traders/investors want to buy quickly, make a huge profit, then get out with the profits. Yes, they’ve forgotten that there is a tax for any income made, and profits from buying and selling a stock are considered income!
Enter the IRA and Roth IRA Accounts…
I personally do most of my trading in IRA and Roth IRA accounts. Why? Because you don’t get dinged with capital gains tax if you continue to buy and sell stocks on a regular basis, and more frequently if you are a day or swing trader.
With an IRA account, you WILL get dinged with the capital gains tax once you withdraw any cash profits, which is considered a distribution.
With a Roth IRA account, you will pay the taxes up front, so that when you buy and sell stocks, then withdraw to take that distribution, it feels like tax-free money because you’ve already paid it. Thus withdrawing any cash profits doesn’t hurt so bad, but you’ve still paid the taxes… up front, yes?
So, most of my trading is done within whatever Roth IRA and IRA accounts my wife and I have. The IRS doesn’t see all this account activity and doesn’t know how much you’ve made that you haven’t withdrawn. When tax time comes, the only thing that shows up are the distributions (withdrawals) that you’ve made for the entire previous year.
Anyway, please keep the tax implications in mind when trading stocks. Capital gains will bite you if you are unaware of them.
In the end, a ‘buy and hold’ strategy for a year or more is advisable and in the long run more profitable.