As economists like to say, "there's no such thing as a free lunch." All that means is that it's impossible to get something for truly nothing. In that expression, perhaps you are trading some of your time for a free lunch. When it comes to investing, the same thinking applies, and with every investment, you are not only taking on financial risk but also likely incurring tax consequences. If you make money, your gains are taxed, and if you lose money, you can deduct the loss from your taxes. This whole tax category is called Capital Gains Taxes, and they can apply to much more than just stocks, such as houses, vehicles, and collectibles. We will focus on stocks. I know taxes are absurdly boring, so here's the cliff note summary on capital gains taxes:
1. Short-term capital gains - Short-term = one year or less that you held the stock. The tax rate is 10-37% as of 2021, depending on your annual income. Aim to avoid if possible, meaning: don't buy and sell a lot within a year for no reason because the tax rate is higher than long-term holdings.
2. Long-term capital gains - Long-term = Greater than one year holding. The rate is 0-20%, depending on your annual income. This rate is almost always better than the short-term rate, meaning that the US tax code incentivizes long-term (1+ year) investments!
There is a handful of specific, primarily retirement-focused ways to reduce or avoid these taxes altogether. 401ks, IRAs, Roth IRAs, and other accounts have special tax exemptions. Next month, we will cover the newest, hottest, golden goose of the bunch - a Roth IRA. Everyone under 40 should have one.
For everything that the upstart brokerage Robinhood has become, I am glad it killed commissions everywhere (remember $10 per trade?), and I'm glad it got lots of young people into investing. Nevermind that lots of young adults treat it like gambling and nevermind that there is little disclosure about the tax consequences of buying and selling stocks frequently, which many Robinhood users do. The truth is that frequent trading like many young people do on Robinhood is an easy way to rack up lots of short-term capital gains taxes and a surprisingly large tax bill that follows in April. Buy stocks you think will do well for a long time. That's what our tax code incentivizes us to do, and it's much simpler than frequent trading at a high tax expense.
- Annika bought 4 shares of BA (Boeing) for about $1000.
- Brenna, Spencer, Lindsay, Chloe, Antonio, Michael, Bryan, Nick, Connor, and Garrett are still sitting on the additional $1000 in cash. Please remember to update the google sheet detail tab when you buy/sell something. I look at the revision history each month so I can include your trade in this newsletter. The summary tab is at the bottom of this email as a picture and the live link to it is here.