When the price of a stock increases, the money that an individual has invested into the company will increase in value as well. This is known as capital gain.
There is no limit on how much a stock can increase in value, meaning that the capital gain that an investor can achieve is unlimited. This is one of the main advantages of investing in stocks, as opposed to other types of investment.
A capital gain is referred to as a ‘paper’ gain, until the investor has sold their stocks. Once the investor has sold their stocks, the capital gain is referred to as a ‘realised’ capital gain.
As much as a capital gain refers to the increase in value of a stock, a capital loss refers to the decrease in value of a stock. Naturally, investors try to avoid capital losses, instead, focusing on gains.
When it comes to earning capital gains from investments, it is easy for new investors to get carried away, especially when it comes to investing in stocks. This is the case because the potential capital gains achieved on stocks are unlimited. It is possible for investors to earn huge sums of money through capital gains.
The key factor that determines how much money an investor earns through capital gains is time. The longer that an investment is held, the larger the capital gains are likely to be. This happens as the capital gains accumulate as each year passes by.
In the short term, the level of capital gain that an investor achieves is likely to be more limited. For example, if an individual invests in a large American stock, it is likely that they will earn something in the region of 20% a year in capital gains. So, if they had invested $10,000, they would have achieved a return of around $2,000.
In addition to time, investors earn higher capital gains depending on the size of the company that they invest in. In general, successful investments into smaller companies will result in higher capital gains than into large companies.
An individual usually has to pay tax on capital gains when they realise them (when they are sold). However, in certain countries, there are rules that reduce or completely eliminate the need to pay tax on capital gains.
For example, in the UK, investors only pay tax on capital gains that are worth more than £12,300 (as of April 2022) in a given tax year. This essentially means that most British people won’t pay any tax on their capital gains at all – unless they are very wealthy.
Therefore, it is important for investors to check out their local capital gains tax policy before investing.
Along with dealing with tax for the purpose of capital gains, many investors also use realised capital losses to reduce their tax burden. If an individual wants to reduce the amount of tax that they pay on their investments and have a paper loss on an investment, then they may decide to realise that loss to lower their taxes.
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