When investing in stocks, bonds, or other assets, investors often consider two types of income: capital gains and investment income. Each has its own advantages and drawbacks, so it’s important to understand the differences between the two. In this article, we’ll explore the key differences between capital gains and investment income, as well as pros and cons of each.
What Is Capital Gain?
A capital gain is the increase in the value of an asset over its purchase price. It is considered to be either long-term or short-term depending on how long the asset was held. A long-term capital gain refers to an asset that is held for more than 12 months, while a short-term capital gain refers to an asset that is held for less than 12 months.
What Is Investment Income?
Investment income is the money earned through appreciation, dividends, and/or interest payments on investments. It can include both capital gains and ordinary income, though ordinary income is only earned if a security is sold for more than what was originally paid for it.
Pros and Cons of Capital Gains
Capital gains have several advantages and disadvantages that should be taken into consideration.
Pros of Capital Gains:
- Long-term capital gains are taxed at lower rates than short-term gains.
- Capital gains are taxed at a lower rate than ordinary income.
- Capital gains provide investors with more flexibility when it comes to deciding when to take gains from an investment.
Cons of Capital Gains
- The stock market is unpredictable, so capital gains can be volatile.
- Capital gains can be difficult to track and report to the Internal Revenue Service (IRS).
- Capital gains are subject to capital gains taxes.
Pros and Cons of Investment Income
Investment income also has its own set of pros and cons.
Pros of Investment Income:
- Investment income provides investors with consistent cash flow.
- Investment income provides investors with an opportunity to leverage their existing investments by reinvesting profits into new investments.
- Investment income is taxed at standard income tax rates, which are generally lower than capital gains tax rates.
Cons of Investment Income
- Investment income is subject to market forces and can fluctuate significantly.
- Investment income is not typically as long-term as capital gains, as most investments need to be liquidated in order to receive a return.
- Investment income can require a significant amount of time to monitor, manage, and reinvest.
When deciding which type of income to pursue, it’s important to consider both the pros and cons of each type of investment income. Both capital gains and investment income have the potential to provide investors with returns, but they often come with different levels of risk and volatility. It’s important to understand the differences between the two income types in order to make the best decision for your financial situation.
