Tax Sensitivity
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Greek ArchitectureIt is well understood that taxes are a detriment to investment returns.  Therefore, it is imperative to manage a portfolio that is subject to taxes in the most tax-efficient manner possible.

Maximizing After-Tax Returns

Many advisors say that they seek to minimize taxes.  It is possible to minimize taxes by simply losing money year after year and never achieve any gains.  This is hardly what investors have in mind!

The goal instead is to maximize returns after taxes are paid.  To illustrate the difference, consider the hypothetical investor who has the choice to invest $1,000 in one of these two bonds:

  Municipal Bond Taxable Bond
Interest $300 $800
Taxes $0 $320 (40% Tax Rate)
After Taxes $300 $480

While the investment in the municipal bond minimizes taxes, the taxable bond maximizes after tax returns.  Of course, this stark example is designed to illustrate the concept and doesn’t reflect current interest rates or taxes. 

We employ three techniques to maximize after-tax returns:

1. Structurally Efficient

The first method is very simple: use tax-efficient investment vehicles.  By using exchange-traded funds to achieve broad diversification, we avoid the pitfalls that are commonly associated with actively managed, open-ended mutual funds. 

Exchange-traded funds are tax-efficient by design.  Their unique structure allows them to track benchmarks with minimal tax consequences. 

2. Tax Loss Harvesting

Tax loss harvesting is the process of selling a security at a loss and replacing it with a security with a similar (though not substantially identical) risk/reward profile.  We can accomplish this with exchange-traded funds and with individual stocks or bonds in both up and down markets.

3. Asset Location

Asset location refers to the strategic placement of investments in different kinds of accounts.  For example, a taxable bond should go into an IRA (or other deferred account) to shield it from taxes where a stock should be held in a taxable account since dividend and capital gains tax rates are low and tax harvesting can be efficiently employed.

 

We are fee only financial advisors focused solely on the goals of our clients, so if you are looking for retirement planning advise, tax deferred investing, needing help with tax saving investments, or tax loss harvesting, Acropolis Investment Management is here to help. Please give us a call to learn more about our comprehensive financial planning services.
 
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