FIN 352 - Professor Dow

Basic Investing Principles:
 Be diversified.
 Hold a portfolio with the appropriate level of risk.
 Asset allocation determines risk and expected
return.


Tax laws can change the relative returns of
different assets.
This might affect how you invest.

Some types of income are taxed differently.

Some assets are taxed differently.

Some accounts are taxed differently.

Capital gains vs. ordinary income.

Taxes on dividends.

Short-term vs. long-term capital gains.

Mutual Funds

Municipal Bonds

Treasury Bonds

Mutual Funds:
 Mutual funds that realize capital gains through
selling shares must distribute these gains
(typically towards the end of the year).
 Shareholders must pay taxes on these gains even
if they did not sell any shares and the distributions
are reinvested in the fund.

Municipal Bonds:
 Income from Municipal Bonds are exempt from
Federal taxes and from state taxes if issued by that
state.
 Compare with similar corporate bonds by comparing
after-tax yields.
 Best for high-income (high-tax-rate) investors.

Treasury Bonds:
 Interest earned on Treasury bonds is exempt from
state and local taxes.
 Taxes still owed on capital gains.
 Interest is not exempt from Federal taxes.

Retirement Accounts
 401k
 Traditional IRA
 Roth IRA
 Other retirement accounts

Health and Education Accounts

401(k)
 Accounts are set up with employer.
 Employer may contribute matching funds.
 Individuals can contribute to their account each year
with pre-tax money.
 Taxes are not paid until the money is withdrawn.
 Individually directed and can invest in most types of
assets, although options may be limited by employer.
 Limits on contributions plus various other restrictions.

Traditional IRA:
 Individuals can contribute to their account each
year with before-tax money.
 Taxes are not paid until the money is withdrawn.
 Individually directed and can invest in most types
of assets.
 Limits on contributions along with various other
restrictions.

Roth IRA:
 Contributions are made with after-tax dollars.
 Income is not taxed.
 Individually directed and can invest in most types
of assets.
 Limits on contributions along with various other
restrictions.

Roth vs. Traditional:
 Roth is taxed now while a traditional IRA is taxed
at retirement.
 Since tax rates at retirement are usually lower
than while working, this is an advantage for the
traditional IRA.

Roth vs. Traditional:
 However, if you contribute the maximum, the
Roth may be more valuable since the limit is in
post-tax dollars.
 There are other differences that can be important.

The Asset Location Decision:
 Determining what assets go in which account is
called the asset location decision.
 Ideally, assets generating income subject to the
highest tax rate should go in tax-sheltered
accounts.

Tax laws can significantly affect your
investment returns.

However, the rules can be complicated and
can change each year, so be sure to do your
homework.