2. Use Retirement Accounts
If there is any drag on return larger than that of investment fees, it would be the effect of taxes. The best way to reduce the tax drag is to invest inside tax-protected retirement accounts such as a 401(k), a Roth IRA, a defined benefit/cash balance plan, and even a health savings account. In these accounts, your money is protected from taxation as it grows. This can result in an increase in return of at least 0.3 percent and perhaps as much as 4 percent per year. In a typical scenario, using a retirement account instead of investing outside of one over a 20-year period results in a nest egg that is at least 20 percent larger.
Explore This IssueACEP Now: Vol 38 – No 04 – April 2019
3. Invest More Tax Efficiently
Even if you must invest outside of retirement accounts, there are methods to decrease tax drag. Broadly diversified index funds and municipal bond funds are very tax-efficient holdings. Some types of real estate investments can shelter income from taxes through depreciation or section 199A deductions. Avoiding turnover reduces capital gains taxes, especially short-term capital gains taxes. Qualified dividends are eligible for a lower tax rate as well. More advanced “tricks,” such as using appreciated shares for charitable donations and tax loss harvesting, can further reduce your tax bill. The only return that counts is your after-fee, after-tax return. Reducing taxes and fees as much as possible could be the difference between having to ask your adult children to pay for your plane ticket to visit the grandkids and being able to spring for an all-expenses-paid cruise for the entire clan.
4. Avoid Losing Strategies
Some investing strategies just don’t work well in the long run and should be avoided. A complete list of these is beyond the scope of this article, but there are a few common ones that are worthy of mention. Investing in whole life insurance is usually regretted by physician investors (75 percent of the time in the surveys I have conducted). The return is too low on a well-designed policy, and most are not well-designed. Speculating in precious metals, cryptocurrencies, and penny stocks is also unlikely to treat you well in the long run. Even investing in individual stocks of good companies introduces uncompensated risk to the portfolio. If a risk can be diversified away, don’t expect to be paid for it. Actively managed mutual funds also have a terrible track record when compared with index funds over the long run.