Stock Market

If you can shelter all the dollars you want to invest in IRAs and 401(k)s, great. But if you put some of your money directly into equity mutual funds without the shelter of an IRA, you will have to pay taxes on any gains the fund makes, even if you immediately reinvest them back into the fund. To avoid this situation, you can limit your mutual fund holdings to one of two types of stock fundsindex funds and tax-advantaged funds:

Index funds mimic the behavior of stocks in a particular index (such as the S&P 500). Because there are few trades, few capital gains are generated, meaning a lower tax bill for you. The irony is that most actively managed mutual funds (the "smart money") fail to beat low-cost index funds (the "dumb money") over long periods of time! The oldest, largest, and least expensive fund is the Vanguard Index 500, which mimics the S&P 500 Index.

TIP: An index is merely a list of assets used as a barometer. The Dow Jones Industrial Average, for example, is the most widely recognized index. It is a list of 30 blue-chip stocks selected by the editors of The Wall Street Journal (a publication of the Dow Jones Company) price-weighted (that is, a stock that is $50 per-share would have a greater effect on the Dow than a stock that was $30). Other famous indices include the S&P 500, the Wilshire 5000, the Russell 2000, and the NASDAQ composite.

Tax-advantaged funds make a conscious effort to minimize taxes by minimizing trading. The fund managers don't completely ignore opportunities to improve the portfolio by buying and selling, but they do it as little as possible to avoid generating taxable capital gains. The fund managers will also attempt to offset gains with losses whenever possibleagain, to reduce taxes.