Capital Gains: Minimizing Your Tax Drag

The difference between the tax man and the taxidermist is the taxidermist leaves the skin."  Mark Twain

As the bull market marches on, many investors find the capital losses they have carried over since 2008 are gone.  Likewise, many investment companies that have earned 5 years of steadily positive returns are finding themselves in the same situation. While these positive returns have had meaningful impact on achieving our financial goals, we are going to start feeling them in the checks we have to write to the government. 

According to a Morningstar and Lipper study, the average annual tax drag on returns for investors is .92% for owners of U.S. equities.  This means that if you average 10% a year returns in your equities, the amount you put in your pocket is 9.08% after you pay the government its share.  From 1996 to 2000, during the extreme run up of the tech bubble, the average tax drag per year was 2.53%1.  This can happen when there has been no bear market or correction for many years.  We would argue it is happening again now.

4 Tips for Managing Taxes

Perhaps the key at this stage of the game is not to avoid taxes but to take many small steps to manage them.  There are several key steps that we utilize in managing portfolios to also minimize taxes.

1. Asset Location:  Place your least-tax-efficient, highest returning investments in your IRA or 401(k).

2. Loss Harvesting: Continually monitor your taxable accounts for losses to harvest rather than only looking in the last quarter of the year. 

3. Maximize contributions to tax-deferred retirement accounts:  This directly lowers your taxable income when maximizing your contributions to 401(k) plans at work.

4. Harvest gains:  In the long run, taking gains during years your income is lower than normal can potentially reduce the amount of taxes paid to the government over a lifetime.

While paying attention to expenses always seems to top the headlines, taxes are just as big of a drag to long-term investor returns. Consult a tax advisor about your particular tax situation.

Angela Palacios, CFP®is the Portfolio Manager at Center for Financial Planning, Inc. Angela specializes in Investment and Macro economic research. She is a frequent contributor to Money Centered as well asinvestment updates at The Center.

1:Source: http://www.lipperweb.com/docs/aboutus/pressrelease/2002/DOC1118788693610.doc

This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Raymond James does not provide tax advice. C14-036848