Boo! It’s the Tax Man!


Don’t let fear of taxes push you towards bad investments. There are many salesmen out there that get a commission to scare you with the tax boogie man and convince you to invest in inferior investments. You do not need an offshore account or whole life insurance to legally pay a low tax rate! For about the last 20 years the Vanguard S&P 500 index fund had a return of about 7.77%. However, I hear the pitch all the time, “don’t invest in mutual funds because have to give half your money to the government.” Is that true? Would the return drop to 4% per year after considering taxes? No! Even a billionaire in the highest tax bracket could have had an effective after-tax return of 6.46% to 7.34% without using retirement accounts or any other special account! Once you start using retirement accounts it gets even better!

Types Returns

Your specific after-tax return is a lot of work to calculate because it is affected by your income, investments, deductions, state residence, account type, and many other items. That is why most big institutions publish a simplified number for the after-tax returns. It is simplified because it assumes you are in the highest federal income tax brackets. They usually neglect state tax since their are 50 different states, but even with that simplification these after-tax returns are usually a pretty conservative estimate for most people.

  1. Return Before Tax: This is usually the highest return and the one that is published everywhere. If you are investing in a Roth IRA this may be your actual after-tax return.
  2. Return After Taxes on Distributions (RATD): When you have mutual funds or ETFs you must pay tax on any dividends or regular paychecks that get sent to you each year. This return accounts for the taxes you have to pay on that distribution income every year, but assumes you reinvest what is left after the taxes and don’t sell any shares.
  3. Returns After Taxes on Distributions and Sales of Fund Shares (RATDSFS): This builds upon the RATD above and adds in the effect of the taxes due to you selling all of your shares at the period covered. Typically you don’t want to sell all your investments in a mutual fund at once to avoid paying so much in tax. So this is a pretty conservative estimate for many people because of this and the fact it assumes you are a billionaire.

A billionaire’s Return

If you dive into the details of a mutual fund or ETF, you should be able to find a table like the one below with after-tax returns listed. Depending on how a fund operates this after tax return can be much higher or lower than the before tax returns. Since the year 2000 this Vanguard S&P 500 mutual fund has an after tax return that is between 6.46% and 7.34%. That is only about 17% to 6% lower than the before tax return of 7.77%! Again this is if you were a billionaire in the highest tax bracket, which you most likely are not! If you are a billionaire please call Tines Capital 🙂

Tax Optimization

Not all investments are so tax efficient. Active investments tend to not have after-tax returns that are so similar to their before-tax returns. Regardless of the investment type the projected after-tax return must be considered carefully because that is what you can actually spend. Taxes are not fun to do or pay, but they don’t have to be scary. Get a fee-only financial advisor like Tines Capital on your side and don’t get spooked!