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Passing Up Tax Breaks

Small investors often look only at the return an instrument is giving them, and overlook how taxes take a bite out of those returns. Morningstar figures that over the 74-year period ending in 2010, investors who did not manage investments in a tax-sensitive manner gave up between one and two percentage points of their annual returns to taxes.

What to do: First, take a look at which of your investments are taxable, tax deferred, or tax-free, says John Sweeney, executive vice-president of Fidelity’s Planning and Advisory Services, and plan to commit some ordinary income to tax-deferred accounts, such as defined contribution plans such as 401(k)s or traditional IRAs and annuities.

When buying and selling stocks that pay dividends, or managing your mutual funds, bone up on tax rules about qualified dividends — those paid on stocks that you’ve held for 60 days or more within prescribed windows that qualify the dividends to be taxed as capital gains.

Selling stocks even a day to soon can result in paying tax on dividends as ordinary income, costing you 10 percent or more.

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