Don’t Pick Investments Based On Taxes
February 25, 2009 – 5:14 amYou may have heard that you shouldn’t pick investments based on taxes, and I completely agree. Most of us have a strong aversion to paying taxes, somehow thinking that “our” money should not be given to the government. Perhaps that’s true, and I’m sure there’s an argument that governments are rarely good stewards of such funds (and neither are any of us usually).
The point is that you shouldn’t pick an investment simply because it minimizes your taxes. Risk tolerance, asset allocation, values, and investment goals should drive your investment decisions. Once you’ve made these decisions, however, the choice of asset location can be greatly beneficial as a way to minimize taxes and therefore allow your portfolio to grow more quickly.
Please note that I’m not saying that there is nothing wrong with seeking out tax-efficient investments like index funds or municipal bond funds. These funds need to fit into your overall investment strategy, however, in order for them to be appropriate.
Our aversion to taxes often reaches an extreme when it comes to mortgages as well. A lot of people think keeping their mortgage is a good idea for “the tax deduction.” This thought process is flawed though, because you’re giving away more than you’re saving. $1,000 paid in mortgage interest will save you $250 if you can deduct it on your income taxes (at a 25% marginal tax rate). If you’d like to keep your $250 tax deduction why don’t you donate $1,000 to a charity. I’d much rather recommend that you give away your $750 net gift than I would have you give it to your banker.
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