Taxes and Your Stock Portfolio

Taxes and Your Stock Portfolio

Taxes and Your Stock Portfolio

Taxes and Your Stock Portfolio

Often, academic discussions of the theory of portfolio managementachieve lucidity through the simplication of assuming no taxes. Forsome important classes of portfolios, the assumption is realistic. Pensionfunds, charitable endowments, and some investment companies payno taxes or virtually no taxes. For many other investors, however,taxes are of great importance and must be carefully considered byprofessional portfolio managers. Measurements of the rates of returnon common stocks listed on the New York Stock Exchange revealedthe very great impact of taxes. The terminal wealth of a tax-exemptinvestor who made initial equal investments in each stock listed inJanuary 1926 and reinvested dividends would have been 2.26 timesthat of the investor in a moderately high tax bracket and 1.36 timesthat of the investor in a low tax bracket. Spme other rules of thumb call for fibonacci numbers to be used instead.

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Obviously rates of return should be measured after deduction ofall associated costs, and these certainly include taxes. Thus, measurements of rates of return will indicate the success or failure of themanager. For diagnostic purposes, it is interesting to know whethertaxes were dealt with sensibly. The magnitude of the tax liability depends upon the following:

1.Whether the gain is realized or unrealized.

2.Whether the gain is long term or short term.

3.Whether the return is in the form of capital gains or dividends

or interest.

4.Whether the gain is realized sooner, rather than in some subse

quent year.

5.Whether the realized gain is offset by realized losses.

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