2 Minute Read
It's amazing what some people will do just to reduce what they pay to Uncle Sam. That includes blindly investing money to save on taxes.
Yes, there are investments such as the traditional IRA (pre-tax savings) as well as the Roth IRA and Roth 401(k), which both grow tax free. They are great for growing your money in mutual funds, and they should be used.
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Our point is that you should not invest just for the tax savings. If you chase investments solely for the purpose of not having to pay Washington, you'll put money into something that doesn't maximize the potential to grow your money.
For example, let's say you buy a local municipal bond. The interest generated by it is tax-free. If you've already maxed out your tax-free Roth IRA and want to keep stocking money away safe from taxes, you might think a municipal bond is a good place to invest further. But that's not the case.
Since the 1920s, municipal bonds have generated average annual returns of around 4%. A regular mutual fund, which you would pay taxes on, averages about 9% after taxes. Over time, that difference is huge.
Putting $2,000 a year ($166 a month) into a 4% investment will turn it into $196,000 after 40 years. Putting that money into a 9% investment (again, that's your after-tax number) will grow it to $777,000! There's no comparison once you run the numbers.
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On top of that, there are some investments that border on being (or actually are) scams. They will heavily promote tax savings to distract you from how bad the investment actually is. If someone pitches a complicated investment that promises big tax savings and big returns, then back away and stay away.
The whole point is to remember to be smart with your money when you are trying to grow it. If you get a tax break along the way, that's great. But don't let the break be the basis for where your investment money goes.
For the best investing advice, you need to work with a professional with the heart of a teacher. Dave's investing Endorsed Local Providers (ELPs) are experienced pros who will give you the same advice Dave would. Get in touch with your ELP today!