Tax Strategies

Hello Fellow Investors,

After diving into a recent AAII Journal article on the tax efficiency of mutual funds and ETFs, I was struck by a burning question: Just how influential are tax considerations when we're cherry-picking our fund investments? Do tax implications sway your decisions, or do potential returns and other factors reign supreme?

Looking forward to hearing your perspectives. Have a wonderful week everyone!

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Jenna Brashear
AAII Community Manager
Chicago, IL
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Hello Jenna,

     For me, tax considerations are relatively low when it comes to my investment decisions.  I do, however, consider taxes when harvesting losses-shedding investments when I know that, even with a loss, the money can be used for better investments as well as offsetting taxes on gains.  I'm also cautious when it comes to entering unfamiliar investment strategies, which might have the possibility of being what I call a tax trap-exotic option strategies for example-and eat deeply into overall profits.  In these cases, I include possible tax consequences as part of my research. 

    I consider myself an average, middle-class investor who knows what he doesn't know.  I love learning with the help of AAII.  I recognize that we are taxed on a marginal basis, so even though gains on an investment might bump me into the next higher tax bracket, I'm only taxed on the marginal increase in income, which meant I made more money.  What's wrong with making more money, even though though the marginal tax rate is higher ?  I know some people will sweat over every tax dollar they must pay, but I do not.  To me, fretting over the tax consequences of an investment is like saying one should turn down a job promotion at a higher salary because it will push them into a higher tax bracket!

     Lastly, I readily admit that my approach to taxes fits my unique investment goals and philosophy.  It might not be suitable to others and their opinions are equally valid.  I am also a retiree from a 38-year career at a Federal national laboratory.  My salary, and blessed lifestyle, was paid from people's taxes, so I don't worry too much about what I pay in taxes. (Although like all Americans, I don't like seeing wasteful spending of tax dollars.)

Regards,

    Ken Milder

Jenna, I wouldn't say I cherry-pick funds based on tax considerations, but they are most certainly an important factor. It just so happens that the most tax-efficient funds are also the ones I choose for long-term profitability, that is, low-expense-ratio domestic equity index ETFs. These ETFs have relatively low turnover, so their holdings are more likely to be long-term, and their distributions are therefore more likely to consist of qualified dividends.

I stay away from bond funds, because aside from being an overall drag on portfolio returns, their distributions are taxed as ordinary income. 

Although tax considerations don't always rule the day in my investment activities, I do not make a move without considering them. For example, this past year, I sold all my ETFs in a couple of retirement accounts and bought individual stocks with the proceeds. I might have done more of the same in my taxable accounts if not for the big gains I'd have to realize (and pay taxes on) in the process.