The Money Mustache Community
Learning, Sharing, and Teaching => Investor Alley => Topic started by: merlin7676 on October 31, 2017, 08:08:40 AM
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A few years ago (before I knew better) I cashed out on some company stock I had. As I wasn't financially educated back then, I didn't know that it had realized gains vs unrealized gains. When I cashed it all out, I had to pay a higher tax on the unrealized gains as I held that portion of stock less than a year since I always bought a few shares per quarter (I think it was a year anyway).
For admiral shares of VTSAX if I were to cash it out (I'm not) would that be the case as well for the index fund or is this something that just effects individual stock? I realize I'd have to pay taxes on the dividends that get reinvested and capitol gains tax but would there be a difference?
The reason I ask is because I've been holding onto about $2k in my savings account as an emergency fund. This upcoming year I was planning on bumping that up another $2 in case I lost my job or had a medical procedure or whatnot. But now I'm thinking rather than holding that money in a savings account where it's making practically nothing, to dump it all into the VTSAX. Then if I ever needed emergency money I'd just sell whatever amount I needed. If I didn't need it, then it would still be getting a better return than in the savings.
Is this a wise thing to do? Or am I missing something?
thanks
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Gains on things you've owned less than a year are taxed at your full marginal rate. If you are in 15% marginal rate there is no tax on gains after 1 year or more.
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Thanks but that doesn't really answer my question. I guess making the title be gains is misleading since that's not focus of what I was trying to get at.
Basically I want to know:
1) is it feasible to keep your emergency money in VTSAX and withdrawal as needed rather than keeping it in a savings account? and
2) if I withdrawal some, how would it be taxed assuming I'm continually adding to it (automatic deposit every two weeks)
thanks
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1) is it feasible to keep your emergency money in VTSAX and withdrawal as needed rather than keeping it in a savings account? and
Feasible but not safe. The point of an emergency fund is to respond to unexpected "emergencies" that arise at unexpected times. It is more likely that you'll need it during economic downturns (maybe your company had layoffs). If you need it when the stock market is down, you'll end up having to withdraw at a bad time in the market and you'll probably have to sell for less than you put in.
2) if I withdrawal some, how would it be taxed assuming I'm continually adding to it (automatic deposit every two weeks)
The default for "which" stocks you sell (either for index funds or individual companies) is a First-In-First-Out policy (although you can also specify exact lots if you want to). So if you're selling part of your fund, it'll start with the oldest shares. The two factors that affect taxes are:
1) How much you bought that particular share for (your "cost basis"). The difference between purchase and sale price is your "capital gains" or "capital losses". They are "unrealized" gains/losses before you sell and it's just paper value depending on the current market rate, "realized" after and you have hard cash in your account.
2) How long you've owned that particular share. More than a year is "long-term capital gains/losses", less than a year is "short-term capital gains/losses".
So every sale will be different, but a single sale could possibly contain all four categories of shares (long-term gains / losses, short-term gains / losses). Each share is accounted for individually. Vanguard (or whoever) will give you a report at the end of the year that tells you what is what.
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Agree with @sherr's answer on the overall substance.
One point is worth clarifying, though:
2) if I withdrawal some, how would it be taxed assuming I'm continually adding to it (automatic deposit every two weeks)
The default for "which" stocks you sell (either for index funds or individual companies) is a First-In-First-Out policy (although you can also specify exact lots if you want to). So if you're selling part of your fund, it'll start with the oldest shares. The two factors that affect taxes are:
Vanguard's default cost basis election for VTSAX (and all other mutual funds) is "average cost".
https://investor.vanguard.com/taxes/cost-basis/methods
You can elect to use FIFO or Specific Lot ID as alternate methods for Vanguard mutual funds (and I recommend doing so).
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Can you explain the "average" cost?? I did not realize that was the default for Vanguard?
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Can you explain the "average" cost?? I did not realize that was the default for Vanguard?
I'll give a link as that's the lowest chance of me introducing an inadvertent error in the explanation:
http://www.investopedia.com/terms/a/averagecostbasismethod.asp