Taxes & trading costs
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Transcript of Taxes & trading costs
Wealth Management Impact of Taxes and Trading Costs
Tax-Aware Wealth Management
• Understanding that maximizing pre-tax return is not the same as maximizing after-tax wealth.
• How taxes influence decisions related to asset allocation, asset location, and portfolio construction.
• Don’t let the tail wag the dog. It is important to be aware of taxes but they should not control your investment decisions
Effects of Compounding on Taxes
Year Value of $1
Pre-Tax Value of $1 After-Tax
% of Pre-Tax Wealth Retained
% of Wealth Lost Due to Taxes
1 $1.10 $1.08 98% 2%
5 $1.61 $1.44 89% 11%
10 $2.59 $2.06 79% 21%
20 $6.73 $4.25 63% 37%
Comparison of Pre- and After-Tax Returns of One Dollar Invested Assumptions: 25% tax rate paid annually: 10% annual returns
Because of this compounding feature, even small reductions in the average tax rate can meaningfully enhance the long-term
growth of wealth.
Source: Goldman Sachs
Source: Goldman Sachs
Source: DFA -Tax Managed Strategies
Erosion of Total Returns
Asset Location
Deciding where to place the carious components of the asset allocation plan among the individuals and entities that make up the investor or family.
What is it?
Why it matters: • Different types of accounts have different types of tax treatment, ie.
IRA’s are taxed differently than trust accounts and individual accounts. • Determining the most appropriate location for an asset can help
maximize your after-tax wealth
Asset Location Examples
Taxable Accounts
Tax-Deferred Accounts
• Taxable bonds • REITS • Any mutual fund that generates high yearly capital gains
distributions
• Tax-friendly stocks due to lower capital gains, dividend tax rates, and the ability to defer gains.
• Riskier and more volatile investments due to the ability to defer taxes and capture tax losses on poor performers.
• ETF’s • Tax-free bonds
Dividends & Gains are Costly to Taxable Investors
Source: DFA -Tax Managed Strategies
Trading Costs Matter When Seeking liquidity, implicit costs typically exceed explicit costs
Source: DFA -Tax Managed Strategies
Trading Small Cap Stocks Can Be Costly
Price & Trading Volume are typically higher for large cap stocks than for small cap stocks
Initiating trades is usually more expensive for small cap stocks than for large cap stocks
Source: DFA -Tax Managed Strategies