To Generate Higher Returns, Minimize Taxes
active management just can’t win.“
– Ted Aronson, CFA, Founder & Managing Partner, AJO Partners
A Real Cost that Wall Street Would Rather Not Talk About
- Traditional active investment strategies can lower total returns by 30% (or more) due to taxes.
- Our intelligent approach to asset location can eliminate or reduce many of the tax consequences of conventional portfolios and help minimize taxes.
- We specifically analyze the tax efficiency of every strategy or manager we recommend to determine the appropriateness in taxable and tax-advantaged accounts.
- Unlike most advisors, we don’t build one-size fits all investment portfolios. We employ customized strategies depending on the tax environment and the client’s unique tax profile.
Ignore Taxes at Your Own Risk
As most everyone is acutely aware, taxes are a real cost. They make our paychecks lower and everything we buy more expensive. They persist throughout the economy and impact nearly every decision we make.
And, for better or worse, they seem to always be headed in one direction: up!
Yet, it is all too often the case that taxes are overlooked as an investment consideration. Why? Common sense suggests that the answer is rather simple:
Taxes are downplayed or ignored because acknowledging their importance would undermine the Wall Street profit machine.
Up, down, or sideways, as long as there is activity, Wall Street is sure to get a cut. Similarly, mutual fund managers generate (very) healthy profits by continuing to promote the fallacy that they can consistently beat the market.
Admitting the importance of taxes would effectively be the death of this approach to investing (active management) because it has detrimental tax affects.
Likewise, Wall Street has a clear incentive to promote action in all markets since they take a slice of every transaction. However, it is exactly for that reason that investors are generally best served by interacting with Wall Street as little as possible.
We incorporate the impact of taxes into the design, implementation, and management of every client portfolio. By taking a tax-focused approach and working to minimize taxes, we help our clients increase their returns and, ultimately, the true spending power in their portfolios.
Here is a brief overview of our process:
- Determine the client’s marginal tax rate on current income and capital gains
- Understand whether the client has tax loss carryforwards that might be used to offset capital gains
- Apply tax efficient asset location to optimize which account holds each asset (e.g. an IRA vs a taxable account)
- For bonds held in a taxable account, compare after-tax yields against municipal bonds of similar duration and credit quality
- For stocks held in a taxable account, consider using tax-managed mutual funds or ETFs to improve after-tax returns
- Monitor the portfolio for opportunities to harvest losses and defer taxes into the future
Don’t Take Our Word For It
– Rob Arnott, Chairman & CEO, Research Affiliates and Robert H. Jeffrey, Retired Chairman, The Jeffrey Company
Selected Supporting Research
The following is a selected list of research papers, articles, and other sources that form the foundation of our approach to investment management and financial planning. You can access our full research library by clicking here.
Arnott, Robert D., Andrew Berkin, and Paul Bouchey. “Is Your Alpha Big Enough to Cover Its Taxes? Revisited.” Investments & Wealth Monitor, January/February 2011. (Download)
Daryanani, Gobind and Chris Cordaro. “Asset Location: A Generic Framework for Maximizing After-Tax Wealth.” Journal of Financial Planning, January 2005. (Download)
Arnott, Robert D., Andrew Berkin, and Jia Ye. “The Management and Mismanagement of Taxable Assets.” Journal of Investing, Spring 2001. (Download)
Arnott, Robert D., Andrew Berkin, and Jia Ye. “Loss Harvesting: What’s it Worth to the Taxable Investor?” Journal of Wealth Management, Spring 2001. (Download)
Arnott, Robert D., Andrew Berkin, and Jia Ye. “How Well Have Taxable Investors Been Served in the 1980s and 1990s?” Journal of Portfolio Management, Summer 2000. (Download)
Jeffrey, Robert H. and Robert D. Arnott, “Is Your Alpha Big Enough to Cover Its Taxes?” Journal of Portfolio Management, Spring 1993. (Download)
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