Please explain to me in layman’s terms what capital gains taxes are and if there is a way to get around them at all legally. Thanks! – Henry
Capital gains occur when the shares of a personâ€™s stock appreciate in value. The monetary difference between what the shareholder originally paid and the value of the shares when sold are the capital gains.
For example, at the beginning of 2003, Henry purchased 100 shares of Exxon Mobil (no investment recommendation intended) for $25 apiece. At the end of 2006, Henryâ€™s shares are now worth $75 each, resulting in an increase of $50 per share. Because of his investment acumen, Henry finds himself with $5,000 ($50*100 shares) in capital gains.
To answer the second part of the question, there are a couple of scenarios where one can reduce the tax burden. The first involves holding shares for over a year in order to pay the current capital gains tax rate, which ranges from 5% to 28%. If a person decided to sell his shares after only three months, he would pay capital gains at his current income tax rate, which is usually significantly higher than the capital gains rate. Click here for more information about capital gains.
The second way to reduce the tax burden is by offsetting the gains with the sale of shares that currently have unrealized or paper losses. Selling your â€œlosersâ€ during the same year you sell your winners will help offset the tax liability. However, be careful not to sell a stock that has decreased in value solely to help offset capital gains. This advice is especially true if the company that currently has a paper loss has bright prospects for future gains!
Matt / Google+
For those of us who have tried investing in individual stocks, here is a great image to capture what many have gone through.
I was thinking about signing up for an account on E-Trade.com but I really don’t have any experience in stock market investing. Basically, do you just purchase a certain amount of shares, wait for them to go up in value, and then sell? Also, how long does it take you to sell the stock and who buys it? Do you get the amount of money the stock is worth or will people try to offer you a lower price then the market value? Please fill me in on this because I’d really like to learn. Greg, Clearwater, FL
Once you have money in a brokerage account, you can immediately begin to buy and sell stocks. There is no limit to how many shares you can buy of each company. If you decide to sell a stock, a market order is executed immediately, as long as the market is still open. A market order means that you sell your shares for whatever the asking price is at that moment in time. The other type of sell order is a limit order. This varies from a market order because you set a price in advance for what you will sell each of your shares for. The order is not executed until another party is willing to pay your specified price for the shares. Sometimes a party is willing to pay what you are asking for right away, however there are times when nobody will want to buy your shares for the price you selected, meaning it is too high. The benefit of a brokerage house is that it will find a buyer for your shares without you having to do any additional work.
Be aware that shares do not always go up in value and sometimes you will need to sell after their value has declined. In this scenario you are selling because the fundamentals of the business you invested in have changed, and you are trying to sell before the stock price declines further. Many investors believe that knowing when to sell shares is a lot more complicated to figure out than when to buy shares.
After you sell your shares, you get the full amount the stock is worth minus the commission you pay the brokerage for selling it for you. However, it is important to keep in mind that you will be paying taxes on any capital gains you may have. A capital gain is defined as the difference between what you bought the shares at and what you sold them at. For example, if you bought 100 shares of Disney at $10 a share and sold them at $15 a share, you would have $500 worth of capital gains ($5 a share * 100 shares = $500). Not to bore you, but you should also be aware of the current tax implications if you sell your shares within a year. If you do this, and have recorded a capital gain, your profit will be taxed at your ordinary income tax level. However, if you hold the shares for at least a year, you will be taxed at a lower set rate. Thus, it is more tax friendly to hold your shares for at least a year. Good luck investing.
Matt / Google+
I’m looking into investing in stocks for the first time. I have heard that money market mutual funds are a good and reliable choice, however I would like to invest in something that has a greater earning potential. I understand that this kind of investing is a little more risky, but I don’t mind taking that risk if I have read up on the company and truly see growth potential. How can I find information on what kind of stocks would be good? – Katie, Maplewood, MN
You are right in that stocks have the potential for greater gains than money market funds. One thing that you need to realize before investing in individual stocks is that they also carry a lot of risk. Most investment advisers urge their clients to invest in mutual funds for the diversification they offer. You said that you do not mind investing in a company where you see growth potential, but you need to keep in mind that the stock market might have already factored this growth into the stock price.
The first thing I would do is to visit your local public library and read everything you can get your hands on regarding investing. If you want to be successful, the first thing you will need to learn is how to interpret financial statements. These are the publications released by every publicly traded company on either a quarterly (10-Q) or annual (10-K) basis. They contain the relevant financial data that illustrates how the company performed for the given quarter or year. A word of warning: financial statements are very difficult for a beginner to understand. Make sure you read the footnotes of an annual report before even thinking of investing your money. Footnotes are where the company’s management likes to hide the bad news.
If you are determined to try your hand at picking individual stocks, I would certainly recommend reading The Intelligent Investor by Benjamin Graham. If you are unfamiliar with the author, he was Warren Buffett’s mentor and his professor at Columbia. The book is a difficult read, but it gives insight into how to select stocks using a “value” approach. Another great book to read is Common Stocks and Uncommon Profits by Philip Fisher. Warren Buffett has said that this book influenced his stock selection process, as it emphasized that buying a great business at a fair price as opposed to a lousy business at a great price.
Once you have developed your own criteria for purchasing stocks, you will need to keep up with current events in the stock market. I have found that the best place to find up to date information is in the Wall Street Journal. The online version of their website posts Wall Street’s breaking news. If you plan to invest in individual stocks you should also be reading industry trade magazines and newsletters to get a better feel for the business you are investing in.
While I have just given you some references that will serve as a starting point, I would like to warn you that successfully picking individual stocks takes a lot of effort. Most people, including the professionals, fail to beat the market average. Keep that fact in mind before investing a penny in an individual stock. Good luck!
Matt / Google+