Taxes may not be the most exciting part of investing, but they can have a meaningful impact on how much of your returns you keep. So what sets tax-savvy investors apart?
According to Kenny Davin, CFP®, vice president and branch leader in Fort Lauderdale, Florida, it often comes down to a handful of habits. Tax-savvy investors tend to think in years, not isolated transactions. They understand the rules, look for opportunities, and avoid letting taxes drive every financial decision.
7 habits of tax-savvy investors
Here’s our take on their top 7 habits:
1. They know their tax bracket
Tax-savvy investors often start with a key piece of information that many people overlook: their tax bracket.
“That’s the foundation for making informed planning decisions,” says Davin. Knowing your marginal tax bracket, the rate that may apply to your next dollar of ordinary income, can help you evaluate the potential consequences of a financial move before you make it.
That knowledge can inform decisions involving:
- Retirement account contributions and withdrawals
- Capital gains strategies
- Medicare-related considerations
- Roth conversions
- Whether to accelerate income into a lower-income year
Take Roth conversions. Moving money from a traditional retirement account to a Roth account can create taxable income in the year of the conversion. But investors don’t need to convert everything at once. A tax-savvy investor might convert only enough to stay within a desired tax bracket, then revisit the strategy in future years. Smaller partial conversions may help manage the immediate tax bite while moving money into an account that can offer tax-free qualified withdrawals. Read Viewpoints: Roth conversions and tax diversification
Rather than focusing only on this year’s tax bill, tax-savvy investors look for ways to use lower-bracket years intentionally and avoid unnecessary income spikes later. Read Viewpoints: Understanding the retirement income valley
2. They use the tax breaks available to them
Tax-savvy investing doesn’t necessarily require complicated strategies. Many people may be able to make significant progress by using the tax advantages already available to them.
Depending on their eligibility, goals, and circumstances, that may include:
- Contributing to a health savings account (HSA), if eligible. Often described as "triple-tax advantaged" HSAs offer 3 potential tax advantages: Contributions may be made pre-tax through payroll deduction (or may be tax-deductible if made directly), any earnings can grow tax-free, and withdrawals for qualified medical expenses are tax-free.1
- Using a flexible spending account (FSA) from your employer to save money pre-tax for eligible medical expenses.
- Contributing enough to a workplace retirement plan to receive the full employer match, when available, which could help reduce current-year federal taxes and offers tax-deferred growth potential. Plus, the employer match is like free money.
- Contributing to a traditional or Roth IRA, which each offer their own powerful tax benefit for saving.
- Using other tax-deferred strategies when appropriate.
The common thread is that these investors think carefully about where to direct their next savings dollar rather than automatically putting every additional dollar into a taxable brokerage account—or a savings account.
Different accounts can serve different purposes. A workplace plan may help build retirement savings, an HSA may help eligible individuals save for qualified medical expenses now and in the future, and a taxable account can offer flexibility for goals before retirement. Tax-savvy investors match the account to the goal rather than treating every dollar of savings the same way.
Read Viewpoints: A step-by-step financial checklist
3. They coordinate across accounts
These investors look across accounts rather than making decisions about each one in isolation. They consider how their accounts and investments can work together more efficiently toward the same goal.
One example is asset location. Different investments may be taxed at different rates, so where you hold an investment can affect its after-tax return. Investments that regularly generate income taxed at ordinary-income rates may be better suited to tax-advantaged accounts. More tax-efficient investments may work well in taxable accounts.
They may also coordinate strategies such as:
- Tax-loss harvesting, which uses investment losses to offset gains in taxable accounts. Certain losses may also be carried forward to future tax years.
- Tax-efficient charitable giving, such as donating appreciated securities when it fits the investor’s broader giving plan.
- Rebalancing across accounts, which may help restore a target investment mix while limiting unnecessary taxable sales.
4. They consider the ripple effects
A financial move can affect more than the tax bill immediately in front of you. Selling an investment may create a short-term or long-term capital gain. Additional income may also affect other parts of your financial life.
Tax-savvy investors seek to understand those trade-offs before acting. They might ask:
- Will this create ordinary income, a short-term capital gain, or a long-term capital gain?
- Could it affect Medicare premiums, financial aid, tax credits, or deductions? Read Viewpoints: Will your retirement income impact Medicare surcharges?
- Would spreading the move across more than one tax year help reduce taxes?
- Do I have investment losses or charitable giving plans that could help offset the tax impact?
- Is the investment rationale strong enough to justify the potential tax cost?
Making informed decisions with a clear understanding of the costs, benefits, and potential downstream effects may help investors manage the taxes paid over a lifetime. Read Viewpoints: How to invest tax-efficiently
5. They don’t let the tax tail wag the investment dog
This may be the most counterintuitive tax lesson of all. Some investors become so focused on avoiding taxes that they hesitate to make investment changes, even when those changes may be in their long-term best interest.
“Don’t let the tax tail wag the investment dog,” Davin says.
For example, an investor with a concentrated position may avoid selling because of the capital gains consequences. Over time, however, that reluctance can create additional risk or prevent them from moving to a more appropriate strategy.
The same principle applies to rebalancing. Selling appreciated investments to restore a target mix can feel painful if it triggers taxes, but allowing a portfolio to drift too far from its intended asset allocation can expose an investor to risks they didn’t mean to take.
In some situations, paying tax today may be preferable to holding an investment that no longer fits your goals, risk tolerance, or overall plan. Taxes matter, but they’re only one part of the decision.
6. They keep good records
Because many tax strategies extend across multiple years, good records can be just as important as good decisions. Organized documentation may help investors and their advisors:
- Substantiate cost basis.
- Track losses carried forward from earlier tax years.
- Document charitable gifts.
- Confirm past Roth conversions or other taxable transactions.
- Reconstruct account history after a transfer or inheritance.
Good records can also preserve future planning opportunities by making it easier to recognize strategies that might otherwise be overlooked. That can be especially important after an account transfer, an inheritance, or a year when several tax strategies are in play.
7. They know when to ask for help
Perhaps the biggest misconception about tax-savvy investing is that successful investors know every tax rule. In reality, Davin says, many of the most effective investors understand that there’s a lot they can’t know.
Tax laws can be complex, and a decision in one area of your financial life can affect another. Financial professionals and tax advisors can help evaluate options, identify trade-offs, and avoid costly mistakes.
Professional guidance can be especially valuable during major transitions, such as:
- A significant change in income
- Retirement or the start of retirement withdrawals
- The sale of a business or home
- An inheritance
- The exercise of stock options
- A large charitable gift or Roth conversion
Being tax-savvy doesn’t mean becoming a tax expert. It means understanding enough to ask questions, seek guidance when needed, and make informed decisions that align with your goals. Find out how Fidelity can help you include tax-smart investing2 as part of your plan: Work with us
Tax-savvy investors think in years, not transactions
When it comes down to it, tax-savvy investing is about considering how decisions work together across accounts, tax years, and life stages.
The most tax-savvy investors understand the rules, use available opportunities, and consider the potential consequences before acting. But they also recognize that taxes are only one part of a larger financial picture. Sometimes a move that creates a tax bill today may still reduce risk, improve flexibility, or support a better long-term outcome.