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Principle 4: Invest Low-Cost and Tax-Efficiently

Watch your costs very carefully, including costs for transaction fees, management fees, and taxes. Remember that regarding investment, a dollar saved is worth more than a dollar earned; this is because while you have to pay taxes on every new dollar you earn, every dollar you save is already taxed and can earn interest on income. Be aware that frequent trading incurs significant transaction and tax costs: keep your costs low.

Defer or eliminate taxes as much as possible. Mutual funds are required by law to distribute 90 percent of all capital gains, dividends, and interest to their shareholders each year. That means you must pay taxes on the distributions from your mutual funds each April, even though you may not have sold a single share of your mutual fund. Mutual funds are pass-through accounts for tax purposes. This means that the tax consequences of the mutual fund are paid by the investor, not the mutual fund. The impact of the decisions that the portfolio manager of the mutual fund makes on your taxes can be significant. Invest tax-efficiently so you do not have to pay more than you need to in taxes. It is not the amount of money you make, but the amount of money you keep after taxes and inflation that makes you wealthy.


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