When discussing building wealth through investing, most people instinctively focus on earning the best possible return. But while returns are important, they only account for half the equation. Equally important is making sure you keep those returns.
Every year, investors pay billions in unnecessary taxes, often not because of what they earned but because of how they earned and managed those investments.
Between realized capital gains, dividends, interest income, and retirement withdrawals, it’s easy to lose 30-40% of your returns to taxes if you’re not deliberate about strategy.
The good news is that you don’t have to lose a significant amount to the taxman. With a bit of knowledge about how your investments are taxed, some thoughtful planning, and a willingness to break a few bad habits, you can legally reduce what you owe and keep more of your returns.
Understanding What the IRS Wants from Your Portfolio
You don’t need to become a CPA to understand how investments are taxed, but you do need a basic understanding of how the IRS treats different types of returns.
Types of Taxable Investment Income
| Type | Examples | How it’s Taxed |
| Realized Capital Gains | Selling stocks, bonds, real estate, or other investment assets for a gain. | Short-term: taxed as ordinary income. Long-term: 0%, 15%, or 20%. |
| Dividends | Payouts from stocks or mutual bonds. | Qualified: taxed at 0%, 15% or 20%. Ordinary: taxed at ordinary income rates. |
| Interest Income | Bonds, savings accounts, or CDs. | Taxed as regular income. |
| Capital Gains Distributions | From mutual funds or exchange-traded funds (ETFs). | Mutual funds may distribute capital gains and dividends that are taxable, even if reinvested. ETFs are often more tax-efficient. Their structure allows them to minimize capital gains distributions. |
| Retirement Accounts | Withdrawals from IRAs, Roth IRAs, and 401(k)s. | Traditional retirement accounts offer tax-deferred growth; withdrawals are taxed as ordinary income. Roth accounts are funded with after-tax dollars; qualified withdrawals are tax-free. |
Here’s an example of capital gains taxation in practice:
Let’s say you earn $5,000 as a short-term gain from selling a stock you held for six months. This is an example of a capital gain that would be taxed as ordinary income. Assuming you’re in the 32% tax bracket, you would owe $1,600 in taxes on that gain (plus any state income taxes).
Had you waited just another six months to sell, your gain might have been taxed as a long-term capital gain at only 15%, saving you $850.
$850 may not sound like much, but if that money stays in your account and compounds for 30 years, it could multiply many times. Those savings start to add up when you apply this practice on a bigger scale.
Maximize Your Returns and How Much You Keep
One of the most common investor mistakes is focusing solely on how much the portfolio earns and ignoring how much money goes out the back door in fees, taxes, and mismanaged strategies.
I once met an investor with a $2.5 million portfolio, paying 2% annually in management fees because his advisor happened to belong to the same country club. There are many other investment firms that charge half of that (or even less) in fees yet still offer excellent services. I pointed out to him that by trying to “keep the peace” and work with his fellow country club member, he was making a decision that would cost him over $1 million in lost earnings over the next 20 years.
He wasn’t being foolish; he hadn’t connected the dots that taxes and fees compound like returns – just in the wrong direction.
Now, to be clear, the goal isn’t to dodge taxes. The goal is to invest smartly so you pay only what you owe and not a penny more. Below are some of the most effective and proven strategies to reduce your investment tax liabilities that we practice at Armbruster Capital Management.
Harvest Losses When Markets Dip
Tax-loss harvesting sounds like something a corporate accountant does in a spreadsheet, but it’s a surprisingly easy and powerful way to mitigate tax liabilities. Here’s how it works:
You sell an investment at a loss and immediately buy a similar (but not identical) asset. This keeps your portfolio exposure the same but provides the economic benefit of a capital loss that can be used to offset realized capital gains, as well as up to $3,000 of ordinary income per year.
If you don’t have gains to offset, you can carry the loss forward indefinitely. So, harvest those losses in bad years and use them in good ones.
Use Low-Income Years to Harvest Gains
Most people know about tax loss harvesting as outlined above, but few people are familiar with the concept of harvesting gains, which you can do – tax-free – in the right circumstances.
Let’s say you retired early and aren’t yet collecting Social Security, so you’re living strictly off cash savings and find yourself in the 15% federal income tax bracket. It may make sense to realize capital gains in your investment portfolio, as this scenario puts you in a low enough tax bracket that long-term capital gains may be taxed at 0%.
Even if you sell stocks, realize the gains, and buy them right back, you may be able to raise your cost basis, which could save you money in future tax bills.
Use Tax-Advantaged Accounts for Growth and Flexibility
Shield growth from annual taxation by protecting your returns from both tax erosion and behavioral mistakes.
| Account | Tax Benefit | Best Use Case |
| Traditional IRA/401(k) | Tax-deferred growth; contributions reduce income. | High earners looking to lower current tax bill. |
| Roth IRA | Tax-free growth and withdrawals. | Those who expect to be in a higher tax bracket during retirement. |
| HSA | Triple tax advantage. | Medical expenses, long-term care. |
| 529 Plan | Tax-free education savings. | College and K-12 tuition planning. |
Keep Trading to a Minimum
Unless you’re a hedge fund manager (and even then…), active trading rarely boosts long-term returns, but it always boosts taxes (at least in a taxable brokerage account), so it’s likely in your best interests to keep trading to a minimum.
| Trading Type | Tax Implication |
| Frequent sales | Triggers short-term gains at potentially high tax rates. |
| Long holding periods | Keeps gains in the 0-20% tax bracket. |
Match Investment Type with Account Type
Not every account offers the same benefits, and not every investment creates the same kind of tax burden. This is where the concept of “asset location” – placing the right investments in the right types of accounts – comes into play, and it can make a significant difference in how much of your return you retain.
Roth accounts (like Roth IRAs or Roth 401(k)s) offer tax-free growth and tax-free withdrawals – a rare and valuable benefit that arguably provides the most powerful type of tax shelter available to individual investors.
If you have an investment that’s expected to grow significantly over time, such as stocks or equity funds, the Roth is an ideal place to put it because the greater the growth, the more tax-free upside you receive.
So why not put every investment in a Roth account?
First off, Roth space is limited, and you generally can’t put that much money into one. Also, Roth accounts may not be the best fit for every investor. It depends on your individual circumstances. For example, if you were to put something like bonds in a Roth account it would be like driving a Ferrari in gridlocked rush hour traffic. You’d just be wasting the vehicle’s potential.
Bonds tend to generate steady, predictable interest and are usually taxed as ordinary income in a taxable account. But they don’t grow much. They’re stable, slow, and often produce modest returns. Bonds in a Roth account would just burn up your best tax-advantaged space on something that won’t take full advantage of it.
And then there are retirement accounts, such as traditional IRAs, SEPs, and 401(k)s, that allow you contribute pre-tax dollars and grow your investments without annual taxation. However, those withdrawals are taxed as ordinary income, so timing matters. You can start taking money out at 59 and a half without penalty, but that doesn’t mean you should. Withdrawing early could push you into a higher tax bracket. In many cases, waiting until required minimum distributions begin (currently age 73) keeps your income and tax exposure more manageable.
| Investment Type | Best Fit Account | Explanation For Best Fit Account |
| Bonds, REITs, income funds | Traditional IRA / 401(k) | Grows tax-deferred so it can be sheltered until retirement. Alternatively, bonds in a Roth account grow tax-free, but with low upside. Taxable accounts are least ideal for these investments as they would be taxed yearly at higher ordinary income rates. |
| High-growth stocks, equity funds | Roth IRA / Roth 401(k) | Tax-free growth amplifies the benefit of compounding in a Roth account. In a traditional IRA, these funds grow tax-deferred, but are taxed as ordinary income on withdrawal. In a taxable account, these investments would grow, but be subject to capital gains tax when sold and tax on dividends as received. |
| Index funds, tax-efficient ETFs | Taxable account | Taxable accounts provide low turnover, qualified dividends, and in the case of ETFs, avoid triggering capital gains. In a traditional IRA, naturally tax-efficient returns are converted into ordinary income upon withdrawal. In a Roth account, you’d waste limited tax-free space on slower growth. |
Here’s how the investment impact can play out in real life:
A client of ours once came to us holding corporate bonds and REITs – both income-heavy – in his taxable account while keeping low-dividend, slow-growth stocks in his IRA. Year after year, he was racking up tax bills that he could have easily avoided. Once we swapped the allocations, the tax drag on his portfolio dropped immediately. It was a simple move, but one that significantly improved his after-tax returns.
And don’t forget about often-overlooked Health Savings Accounts (HSAs) that offer a rare triple tax benefit: tax-deductible contributions, tax-free growth, and tax-free withdrawals if used for qualified medical expenses. Similarly, 529 Plans allow your investments to grow and be withdrawn tax-free when used for education.
So, it isn’t just what you invest; it’s where you invest it.
A well-structured portfolio that uses each account type wisely can quietly save you tens or even hundreds of thousands of dollars over time. All while maintaining a respectful distance from the IRS.
Why Pay More Than You Owe?
I highly doubt anybody wakes up in the morning excited to think about tax brackets, withdrawal sequencing, or where their REITs are sitting. But if you’ve done the hard work of building wealth through saving, investing, reinvesting, and holding through the chaos, you owe it to yourself to keep more of what you earned.
Most investors don’t blow their returns on bad decisions. They lose them slowly, year by year, through taxes, fees, poor placement of assets, and a reluctance to shake up the status quo (why hand that much of your investment return over to the IRS or the friendly neighborhood broker who golfs at your club just because that’s the way you’ve always done it?).
Small strategic changes, like holding your winners a bit longer, harvesting your losers at the right time, and allocating the right investments to the right accounts, can quietly add tens or even hundreds of thousands of dollars to your bottom line.
So, take a look under the hood. Question the habits. Rerun the numbers. Tax efficiency isn’t about exploiting loopholes – it’s about being more intentional with your money. And a few smart moves could save you tomorrow.
For more information about Armbruster Capital or on investment taxes, contact us through our website or call (585) 381-4180.
Disclaimer
As portrayed in this post, Armbruster Capital Management’s views are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Investing involves risks, and the value of your investment will fluctuate over time, and you may gain or lose money. Past performance does not guarantee future results.