Deconstructing taxable investment returns

We offer a practical overview of a common return framework that we hope will help taxable investors better understand their returns, and in turn, their investments.

The views expressed are those of the author at the time of writing. Individual teams may hold different views. The value of your investment may become worth more or less than at the time of original investment.

Reviewing investment performance can be challenging for taxable investors. A typical mutual fund prospectus presents taxable clients with three different sets of returns. Despite this common framework, these numbers are often misunderstood, potentially leading to suboptimal investment decisions.

Clearing the confusion

An overview of the data presented in a typical prospectus could help taxable investors more effectively use this framework to understand their investments.

1230_icon_1_100x200
​RETURN BEFORE TAXES

These figures are typically the focus of investors but do not reflect fees or taxes.

1230_icon_2_100x200
​RETURN AFTER TAXES ON DISTRIBUTIONS

This second set of returns includes taxes on income realized (and, in the case of a mutual fund, distributed) by the fund during the current year. These are pre-liquidation returns.

1230_icon_3_100x200
​RETURN AFTER TAXES ON DISTRIBUTIONS AND SALE OF SHARES

Finally, this set reflects taxes on both realized taxable income and on a gain or loss realized on a hypothetical liquidation of an investment in the fund. These are post-liquidation returns.

Considering both pre- and post-liquidation returns is a vital part of analyzing an investment. The return differential can be quite significant. The current 23.8% federal income tax rate on long-term capital gains sets a theoretical minimum on post-liquidation “tax drag.”

Understanding the historical after-tax return can help taxable clients better evaluate prospective investments, in the context of a desired holding period. To learn more, see the practical example and three key principles we live by outlined below.

taxes in practice: dissecting pre- and post- liquidation returns

The cost difference between pre- and post-liquidation returns can be substantial. An investor would have kept 81% of pre-tax income over a 10-year period pre-liquidation. But including liquidation costs, the investor would have kept only 75% of pre-tax returns.

Leveraging this tax framework

Three principles we live by:

magnifying glass

We focus on after-tax returns.

After-tax returns net of fees allow us to see both pre-tax investment skill and the degree to which an investment team is able to minimize taxes.

hour glass

For long-term investments, we focus on pre-liquidation returns.

For core equity holdings, we believe tax-efficient compounding is often more important than taxes to be paid in the distant future.

stop watch

For shorter horizons, we focus on post-liquidation returns.

While compounding is still meaningful for tactical allocations, taxes on liquidation have a bigger present-value impact on their shorter holding periods.

We hope leveraging this framework will help taxable investors better understand their returns and, in turn, their investments.

Contact us to continue the conversation.

Learn more:
https://wellington.com/en/family-offices
Tax investing audiocast

RECOMMENDED FOR YOU

Climate change and emerging markets: Assessing opportunities and challenges
September 2020
Climate change and emerging markets: Assessing opportunities and challenges
,
Public Permanent Capital: Combining attractive qualities of private and public equity investing
Learn how two veteran investors, one from Wellington and one from Housatonic Partners, happened to connect and bond over a passion for identifying companies led by strong capital allocators with extended time horizons. In this audiocast, Portfolio Manager Mark Whitaker and investor and author Will Thorndike discuss how they came to ultimately forge a collaborative investment approach named Public Permanent Capital, and why they believe it’s such a timely idea.
June 2020
Public Permanent Capital: Combining attractive qualities of private and public equity investing
,
Lessons from 200+ years of energy evolution: What comes next?
In search of guideposts for the next transition in the energy economy, Multi-Asset Portfolio Manager Scott Elliott considers the evidence from previous transitions and draws conclusions that could shape future investment decisions.
May 2020
Lessons from 200+ years of energy evolution: What comes next?
,
Value investing’s existential crisis
In this video series, Multi-Asset Strategist Adam Berger sits down with researchers and portfolio managers from across our equity and alternatives platforms to discuss the long stretch of underperformance by value stocks.
March 2020
Value investing's existential crisis
,
Key changes in the tax code<span>Tax incentives and incremental alpha</span>
The 2017 tax law buoyed stock prices – but many changes are still opaque for investors. To help understand the new landscape, we profile what changed and what stayed the same.
January 2020
Key changes in the tax codeTax incentives and incremental alpha
,
Deconstructing taxable investment returns
We offer a practical overview of a common return framework that we hope will help taxable investors better understand their returns, and in turn, their investments.
January 2020
Deconstructing taxable investment returns
,
The reemergence of global macro strategies in an unsettled world
Shifting financial and economic conditions have prompted investors to reexamine the diversifying elements of their portfolios, but they are finding few good options available. In this paper, we look at how global macro investment strategies can help.
January 2020
The reemergence of global macro strategies in an unsettled world
,
Fixed income needn’t be so taxing
We believe tax management of fixed income should be at the fore of investors’ minds, given the heavy tax drag often imposed by these holdings. Three Wellington thought leaders tackle this vexing issue and offer potential solutions.
October 2019
Fixed income needn't be so taxing
,

We use cookies to improve your experience on our website. To accept cookies click Accept & Close, or continue browsing as normal. For more information, visit Cookies & Tracking NoticE.