Taxes on Investments

This article is not tax advice. Please consult with a tax accountant to make any tax calculations and decisions.

High investment returns can obscure an important factor regarding taxes. That is, the actual return realized by an investor is net of both fees and taxes generated in earning those returns.

An investor looking to lower their investing costs will utilize vehicles, such as index investments, with low expense ratios. However, taxes, a less obvious and often overlooked cost, are omitted from the expense ratio.

Investments generate taxes across three core areas:

1. Within investment funds
2. During investment transactions
3. Through the choice of investment account

1. Taxes Generated Within Investment Funds

Taxes strengthen the argument against actively managed funds. Frequent trading inside an active mutual fund or exchange-traded fund (ETF) creates taxable events in the form of capital gains.

• Short-Term Capital Gains & Ordinary Dividends: Triggered when positions are sold within one year of purchase. These are taxed at federal ordinary income tax rates.
• Long-Term Capital Gains & Qualified Dividends: Apply to positions held for longer than one year. These are taxed at preferential federal rates (0%, 15%, or 20%) based on taxable income.

Trading activity inside an actively managed fund creates tax consequences that flow directly to your personal tax return (Form 1040, Schedule D), even if you didn't sell shares of the fund yourself.

Conversely, low-cost index funds and ETFs feature minimal trading activity, generating far fewer taxable distributions. ¹

2. Taxes on Investment Transactions

Selling an individual investment triggers a capital gain or loss reported on Form 1040, Schedule D:²

• Short-Term Capital Gains: Assets sold within one year of purchase date.
• Long-Term Capital Gains: Assets sold after holding for more than one year.

Depending on where you reside, local and state capital gains taxes may also apply.

3. Taxes Affected by Investment Account Type

The type of account holding your assets dictates how and when you are taxed:

• Tax-Deferred Retirement Accounts (Traditional IRA / 401(k)): Contributions are generally pre-tax, and investments grow tax-deferred. You avoid year-to-year capital gains taxes. Withdrawals are taxed as ordinary income, and Required Minimum Distributions (RMDs) begin according to current federal age guidelines.
• Taxable Brokerage Accounts: Standard brokerage accounts require paying taxes on income and net realized gains annually. While capital gains or losses are realized only at sale, interest and dividends are taxed yearly as income, even if automatically reinvested.
• Education Savings Accounts (529 Accounts): Designed for education expenses, allowing investment earnings to grow tax-free when used for qualified expenditures.

How We Help Clients

At One Day In July, we help prospective clients understand the direct and indirect costs of their current holdings—including advisor fees, fund expenses, sales charges, and unnecessary exposure to investment-related taxes.

We work with you to understand your short- and long-term financial goals and construct a tax-efficient index fund portfolio designed to help keep more of your money working for you.

One Day In July LLC is a Registered Investment Advisor. The above article is based upon tax rules in place as of 2026. These rules may change in the future. The above should not be construed as tax advice, and investors should consult their tax professional.

1. Vanguard (accessed August 2026). “How Mutual Funds and ETFs are Taxed.” https://investor.vanguard.com/investing/taxes/mutual-funds-etfs
2. IRS. Form 1040, Schedule D Information. https://www.irs.gov/forms-pubs/about-schedule-d-form-1040