Taxes

I've always said that for taxable investment accounts the best thing I can do every year is give a client taxable losses and let the gains continue to accrue tax deferred inside the account.  Somebody else agrees with me.  Saw this post a while back over at the Reformed Broker.com on tax efficiency via a fellow named Bob Seawright.  {Green highlights are mine.}

"Tax efficient is better. Experienced money managers routinely argue that you shouldn’t “let the tax tail wag the investment dog.”  And it’s true that a poor investment isn’t often salvaged by good tax treatment.  However, the difference between having a $1,000 gain taxed at the long-term capital gains rate of 20 percent versus the income tax rate of 35 percent would save the investor $150 before considering state taxes and without even using the top income tax rate or noting that other new provisions could hit investment income as well.

Individuals with adjusted gross income over $200,000 ($250,000 for joint-filing couples) will face a 3.8 percent Medicare surtax on investment income. Singles who earn over $400,000 (joint filers over $450,000) will face a new top marginal tax bracket of 39.6 percent. Those same people will see their tax rates on dividends and long-term capital gains go up to 20 percent from 15 percent. And limits on itemized deductions and personal exemptions will start to kick in on incomes over $250,000. Details on recent tax law changes are available at the fine blog of Michael Kitces (here).  Taxes matter a great deal.

Moreover, tax efficiency has not generally hindered performance.  According to Lipper, for example, over the 10 years ended December 31, 2012, tax-managed large cap core stock funds returned an annual average of 5.82 percent after taxes while the entire category (which includes hundreds more funds) returned 5.71 percent after taxes.  Tax efficiency is the appropriate default setting."

Almost every mutual fund or public institution that publishes a track record fails to talk much about taxes.  The tax implications of owning a mutual fund that say returns 15% with over 100% turnover, much of it usually at short term rates, can profoundly impact your performance in the long run.  Likewise a trading account that does not maximize tax strategies and returns large amount of capital gains can see those actual returns eroded to the point that it may not have made sense to be trading in the first place.  

One of the advantages of ETFs is their tax efficiency.  In the end it's not what you make, its what you keep!

Links:  Reformed Broker.com:  Tax Efficiency.

            Seawright-Original Post.