We target after-tax returns. Our objective is to invest in shares of great companies for decades before we sell and then pay taxes.
Charlie Munger, Warren Buffett’s plainspoken and less-famous partner has said that “If you sit back for long, long stretches in great companies, you can get a huge edge from nothing but the way that income taxes work.” The effects of taxes on your after-tax investment returns matter more than Wall Street lets on.
Let’s say you buy 1,000 shares of a great company at $10 per share for a total of $10,000 and hold them for 30 years. They go up 15% per year and you only pay taxes when you sell it or take it out of a traditional IRA after 30 years. We pay a 35% tax at the end in either case, and you get to keep 13.3% per year after-tax annual return or after the miracle of compounding, you would have $662,000 before the tax at the end and $430,000 after the tax.
In contrast, if you bought the same shares at the same time but had to pay taxes every year of 35% out of the 15% per year that you earned, then your return would be the same return of 15% minus 35% for taxes or only 9.75% per year after tax. In this case, the original $10,000 is worth only $163,000 after 30 years. Not bad but $267,000 less than if you had deferred taxes until the very end.
Mutual fund investors may receive an unexpected tax bill. Whenever a fund sells a position at a profit or reinvests dividends, the resulting capital gains or dividends are distributed to all shareholders (in proportion to their holdings). It doesn’t matter how long you held the fund—you may have to pay tax on long or short-term gains and dividends for transactions you didn’t make, even in years when the fund shows a loss. Mutual funds may have benefits for some small investors, but tax efficiency is not one of them.
We invest your money directly into shares of great companies in SMAs. It gives you more flexibility and control. By investing in underlying shares rather than mutual funds, you get to choose which shares of great companies to sell and whether to realize short-term gains, short-term losses, long-term gains, or long-term losses.
We maximize the value of tax-loss harvesting by incorporating it into our year- round tax planning and investing process.
Our strategy that changes an investment that has lost money into a tax winner is called tax-loss harvesting, and it is done most efficiently when you have an SMA of individual stocks.
A gain is when your stock increases in value after your purchase. A loss is when the stock decreases in value after your purchase. When you sell a stock and make a profit, that’s a realized gain. On the other hand, if you sell a stock at a loss, that is, for less than the original purchase price, you have a realized loss.
Realized gains are subject to the capital gains tax. Realized losses can either offset realized gains on other stocks or can offset $3,000 of ordinary income on a joint tax return in one year. Unused losses can be carried forward indefinitely. Realized losses can help offset realized gains to lower this year’s tax or future years’ tax bills.
Tax-loss harvesting and portfolio rebalancing go together. In addition to keeping your portfolio aligned with your goals, periodic rebalancing provides an opportunity to reexamine lagging stocks that could be candidates for tax-loss harvesting.
A tax lot is a record of all transactions and their tax implications (dates of purchase and sale, cost basis, sale price) involving individual shares in a portfolio. If you have acquired multiple tax lots involving the same stock, either through new purchases or dividend reinvestments, your tax cost basis can be calculated either as a per- share average of all the purchases (the average-cost method) or by keeping track of the actual cost of each tax lot of shares (the actual-cost method).
For tax-loss harvesting, the actual-cost method allows you to designate specific, higher-cost shares to sell, thus increasing the amount of the realized loss. We consider specific tax lots to make strategic decisions about which stocks and how many shares to sell making a big difference in the taxes owed on those sales.
We sell shares trading at a price that is below our purchase price and then offset realized investment gains with those losses all specific to your own account. The result is that less of your money goes to taxes and more is invested and working for you.
Filing your taxes can be an involved process, and accidental errors can be easy to make. Grab this handy guide to get some tips to avoid some common filing errors.