Compared to most other investment vehicles, stocks offer attractive returns over long periods of time. However, many individual stocks can be subject to punishing volatility and temporary losses during transient periods of market weakness. For inexperienced investors, such periods of volatility can create serious headaches. During major downturns like the financial crisis of 2008, many investors choose to sell their stocks at a loss and leave the market altogether. Although this is an understandable response to periods of financial stress, it might not be the best long-term means of combating volatility. Even after accounting for the effects of violent downturns, studies have shown that the stock market produces long-run annual returns of at least 10 percent per year.
Unfortunately, these gains can be reduced by taxation, fees and other miscellaneous expenses. If you're wondering whether you'll be required to pay capital gains taxes on the U.S.-traded stocks in which you've invested, you'll need to keep several things in mind.
First, you can use a tax-protected retirement account to avoid paying capital gains taxes on the proceeds from your stock sales. As long as you keep the proceeds in the account and resist the urge to make premature withdrawals, you can grow your retirement savings on a tax-free basis for an indefinite period of time.
However, your retirement account may be subject to certain contribution limits. If you're under the age of 50, you can contribute just $5,000 per year into your tax-protected IRA account. If you're over the age of 50, you may be able to contribute as much as $6,000 into your account. Before you make any contributions, be sure to check with a licensed tax professional.
If you're trading stocks in a U.S.-based traditional brokerage account, you'll almost certainly be required to pay capital gains on your earnings. For tax purposes, "capital gains" are defined as the profits produced by the sale of a given stock. Although the tax rates on capital gains fluctuate from year to year, it's safe to assume that you'll need to forward at least 15 percent of your profits to the IRS.
Since "short-term" capital gains are taxed at higher rates than "long-term" capital gains, you may wish to avoid selling stocks that you've held for fewer than 12 months. It's also crucial to note that dividends are taxed as regular income. When you calculate your total investment-related earnings at tax time, you'll need to account for your capital gains and dividend earnings separately.