Portfolio Design: Maximizing After-tax Returns

Even when we do everything right – listen to the evidence, invest for the long-term, tune out the market noise – we don’t invest in a vacuum. Ultimately, we need to go beyond the returns, dollar signs, and percentage points and begin to look at our portfolio for what it is:  A means to an end. For most of us, these assets will be liquidated over time and used to fulfill our goals and objectives through retirement. Unfortunately, Uncle Sam is going to want his share. As the saying goes… death and taxes.

So, while you can’t control markets, or influence tax law, you can take steps to maximize what should be everyone’s goal at the end of the day; more cash in your pocket.

Ways to Help Maximize After-tax Returns

Tax-managed Equity Funds

Holding tax-managed funds within a portfolio is an easy and effective way to offset some of the tax consequences associated with mutual funds.  This is accomplished by letting the fund companies do the work for you. Often, these funds are designed to mirror their non-tax-managed counterparts while seeking opportunities to manage around taxable distributions. In this way, fund companies seek to further reduce an investors overall tax burden, while maintaining comparable expected returns.

Looking specifically at a fund company we utilize, Dimensional Fund Advisors accomplishes this goal through the following considerations:

Capital Gains Distributions

  • Avoiding Short-term Capital Gains- Lower turnover within the funds increases long-term holdings.
  • Tax Loss Harvesting – Generating capital losses to offset both short- or long-term capital gains.
  • Tax lot Relief Method – Building up positions through multiple lot purchases, allowing flexibility when selling securities.

Income Distributions

  • Maximize Qualified Dividend Income (QDI) – Non-qualified dividend income is often taxed at ordinary income rates, where QDI may be taxed at lower capital gain rates.

Tax Efficient Asset Location

Avoid holding identical assets across numerous accounts within a portfolio, especially when utilizing a combination of taxable and tax-advantaged accounts. In the same way that each of these accounts can have different tax treatments, each investment can have its own tax rules.

As a rule of thumb, we would prefer to hold tax-inefficient investments within a tax-advantaged account, with the opposite holding true for tax efficient investments. As a result, we are better able to manage the taxable distributions to further enhance the after-tax return of the portfolio.

In general, fixed income (excluding Municipal Bonds and US savings bonds) tend to be on the tax-inefficient side of things, while equities fall into somewhat of a grey area. Depending on investment strategies, equities vary on their tax efficiency. Indexed or passive funds tend to be more efficient than actively managed funds, and the same is true in general of large-cap funds compared to small-cap.

It is important to note, however, that everyone’s situation is unique, and depending on your goals, risk tolerance, time horizon, and tax bracket, you may find the effectiveness of these strategies diminished.

Share Button

Top 3 Evidence-Based Reasons to Invest Internationally

U.S. stocks have significantly outperformed international stocks in recent years. Further, U.S.-based multinationals are major players in the world economy. Here at Claris, we have had clients ask whether they…
Read More.

Investment Methodology White Paper

A critical component to your client experience with our firm is the formation of a robust investment plan to guide you and us as we build and maintain your portfolio…
Read More.

Scott Iverson Named Member of Claris Advisors, LLC

Claris Advisors, LLC is proud to announce that Scott Iverson, CFP®, ChFC, CEBS, CRPS has been named a Member of the company effective 1/1/20. Scott has served as a wealth…
Read More.

Where Has the Value Premium Gone?

As evidence-based investors, Claris and our clients follow decades of Nobel Prize-winning research and tilt investment portfolios toward long-term sources of higher expected returns. These sources, or premiums, were conclusively…
Read More.

Volatility Continues as Trade Tensions Remain High

Coming off years of strong investor confidence, volatility has become the name of the game. 2018 was a hard year for equity markets when, for the first time in almost…
Read More.

Pouring Cold Water on the Bucket Investing Strategy

The bucket strategy is a commonly used investment strategy, dividing a retirement portfolio into at least two different accounts. One account is invested in a more aggressive manner for future…
Read More.