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What Is The Relationship Between Taxes And Investment Strategies?

What Is The Relationship Between Taxes And Investment Strategies?

May 20, 2022

What Is The Relationship Between Taxes And Investment Strategies?


The profitability of your investment is relatively dependent on your chosen investment strategy and related tax liabilities. Without a proven tax-efficient investing strategy, you'll continue to toil like everyone else and end up paying abnormally high amounts to Uncle Sam. 

But it doesn't have to be that way. Regardless of where you are now on your financial journey, an improved understanding of the relationship between taxes and investment strategies will put you on the right path toward growing your wealth. 

Beyond what you know now, it is obvious that a better financial future doesn't happen by accident. The investment strategies you adopt today will influence your tomorrow's tax liabilities. 

What Is an Investment Strategy? 

An investment strategy is a set of principles, rules, and procedures for investing to accomplish specific goals. Depending on financial goals, risk appetite, background experience, and other factors, investment strategy may differ from one context to another. 

Just as there are differences regarding the types of investments or assets, investing strategies also differ. Interestingly, what is suitable for investor A might not be the same for investor B. 

Before we dive deep into the relationship between taxes and investment strategies, we will review diverse examples of investments. From these specifics, you might be able to pick those that are best suited for your current financial status, goals, risk appetite, and tax bracket. 

Value Investing Strategy 

Value investing is about looking for and investing in undervalued companies, stocks or assets for potential profits. It is one of the most popular investing strategies used in the stock market. 

The premise is that some companies and stocks are usually undervalued at any point in time. Then, the core responsibility of value investors is to research, analyze and understand the core operating fundamentals that make such assets undervalued. 

Growth Investing Strategy 

Instead of focusing on undervaluation principles, a growth investment strategy is about looking into a company's future earnings and growth potential. In most cases, growth investors don't care much about dividend earnings. The big question, in this case, is – how and why would a company sustain its growth momentum over a specific period? 

Successful growth investors often look at the overall industry and market outlook. Although it is not always about speculative trend-chasing, it is also important to understand a company's operating fundamentals in relation to its target market. 

Another important factor in growth investing is the performance of the executive management team. In addition to performance metrics, a growth investment strategy often requires a long-term holding period. 

Passive And Active Investing 

Passive investing is about buying and holding income-generating assets for a specified period. During the holding period, there are relatively no responsibilities required on the side of the investors. In contrast, active investing requires constant buying and selling of assets within short periods. These are parallel investing strategies. 

The one you choose depends on some of the factors mentioned earlier in this post. With active investing, high transaction fees are usually involved. And that's why it takes many calculations to make it profitable. 

Dividend Growth Investing Strategy 

Dividend growth investing is about leveraging the power of compound interest. What happens is that dividend growth investors look specifically for companies with a track record of paying dividends over a long period. With such companies, you can build compounding wealth by investing and reinvesting your dividend earnings. Most times, the goal is to increase the amount of dividend income over the long term. 

Income Investing Strategy 

Here is another example of an investing strategy that focuses on income-generating stocks and other types of assets. In addition to the traditional dividend, you might be earning interest from bonds. 

Investors who adopt this strategy look for rental income-generating properties in the real estate market. While the asset is generating income, the value may appreciate over the lifetime of the investment. 

Very IMPORTANT to keep in mind: 

****Past performance is no guarantee of future earnings****.

Investment asset diversification – In some specific contexts, the type of investment asset you own determines how much taxes you'll be paying. For example, investment income from municipal bonds is exempt from federal income tax in the United States. 

However, municipal bonds are classified as taxable investments in some states. When choosing the type of asset for investment purposes, it is important to understand the legal tax liabilities stipulated for such assets. On the other hand, when asset diversification is your top priority, you must consider this seriously. 

Asset ownership duration – How long you have owned an asset also influences how much tax you pay to the government. Another important factor is the investment income you earn from an asset. 

For example, if you sell a real estate property you have owned for less than one year, the capital gain from the sale is taxed differently in comparison to rental income earned from the property. 

Assuming you sold an asset you have owned for less than a year, you'll be liable to pay the ordinary income tax rate, subject to your current tax bracket. 

Jurisdictional Tax Regulations – At the federal level, investment tax management is relatively easier. But when the complexities of various state laws are introduced, the whole picture becomes confusing for most average investors.

Depending on your investments' registered location, what you pay in taxes will always differ from one state to another. On one side of the equation, the size of your investment and your current tax bracket will determine what you'll pay from one jurisdiction to another. 

In the context of corporate tax, the size of your investment income will also determine the level of complexities involved. 

Why You Need Both An Investment Professional & Tax Advisor 

Hiring a professional tax strategist and or experienced financial advisor is certainly better than relying on your limited knowledge for successful navigation of the investments including tax liability landscapes. One thing you have to keep in mind is that hiring a professional may be less expensive than being a ‘doing-it-yourself in very complex financial environments. Ignorance may prove expensive in challenged markets.

Diddel & Diddel offers financial coaching advisor services. We are able to help you navigate the complexities of investment opportunities, and offer tax reduction strategies that will help you keep more of what you make. 

Key benefits of getting our coaching services include the following:

  • Get educated regarding taxable, tax-deferred & tax-free strategies 
  • Avoid costly mistakes now and in the future due to a lack of knowledge
  • Discover investment opportunities that you may be qualified for 
  • Gain access to dependable and experienced career professionals 
  • We can coach you to make beneficial decisions for your portfolio 

Now that you know the relationship between taxes and investment strategies, you can take these points to think through your current goals, risk appetite, and financial resources. 

If you are a new investor or even a seasoned one, you need to understand the investment opportunities as well as tax advantages available to you.  The Diddel and Diddel team welcomes your call: 203-708-9033