Avoiding Taxes and Transaction Costs

“Rules are made to be broken.”

“… too much of a good thing …”

“You can't escape death and taxes.”

As cliches go, these three aren't bad ones to keep in mind when investing. When using formula plans for “timing” investments, the very rules that can help you corral a higher return can also saddle you with unnecessary taxes and hogtie you with transaction costs. Excessive trading is expensive in terms of both commission expenses and your valuable time. Simply selling a few shares of a stock or fund may incur a tax liability, not to mention the paperwork needed for you to exercise the “privilege” of calculating and paying that tax. This chapter will analyze some of the pitfalls you may encounter in formula investing, along with some solutions that will help you tailor a plan to suit your needs.


One of the advantages of value averaging and some other formula investment plans is that they help send you “sell” signals that, supposedly, enhance your investment returns. Such signals may, however, diminish your returns by causing you to pay premature taxes on your capital gains. As of 1993, there are no “tax preferences” on capital gains1 to ease the tax burden on your profits.

The Advantage of Deferred Gains

You pay taxes on capital gains only when you realize the gains (sell profitable positions). Delaying the taxes on capital gains by not selling profitable shares now is beneficial on at least three counts. ...

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