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