As observed in Chart 1 for the active fund, the portfolio would have grown in value from $1,000,000 (average rate of 7.25%) to approximately $4,450,000 without accounting for tax ramifications. However, as shown in Chart 3, after factoring in taxes the portfolio value would been reduced to about $3,220,000. Taxes absorbed about $1,230,000 or 35.65% (taxes paid/pre-tax gain = $1,230,000/$3,450,000) of the gain with the active fund.
The index fund, as shown in Chart 2, would have grown from $1,000,000 to approximately $4,800,000 (average rate of 7.63%). Chart 4 illustrates the impact of taxes on the passive fund, which would have reduced the portfolio value to approximately $3,770,000 after paying for taxes. For the passive fund, taxes absorbed about $1,003,000 of the about $3,800,000 pre-tax gain, or 26.39% (taxes paid/pre-tax gain) of the gain.
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The active fund produced less return and almost $230,000 more in tax ramifications. Many managers today produce higher turnover rates than the 200% the active fund in this analysis examined. Imagine how much more the tax bite would be with a manager who exhibits more than 400% turnover. This analysis illustrates how highly active, tactical managers may lead to higher tax bills, which is likely to make Uncle Sam happy. It also highlights how a strategic approach utilizing passive, indexing strategies may lead to higher returns and less taxes paid to Uncle Sam, which is likely to lead to happier investors.
This basic tax analysis exemplifies one reason why TOPS® portfolios are structured utilizing cap weighted, low cost index based ETFs. TOPS® portfolios are structured with the goal of offering investors the highest opportunities for long-term portfolio success. As examined, a strategic approach leading to lower portfolio turnover combined with low cost, tax efficient indexing may lead to better after-tax returns, which should likely benefit long-term investors.
Chad Roope is Vice President-Investment Management of TOPS/ValMark Advisers, a participant in the ETF Strategist Channel.
[related_stories]Important Disclosure:
Charts are for illustrative purposes only and do not reflect an actual client experience. ValMark Advisers, Inc. (“ValMark”) is a federally registered investment adviser located in Akron, Ohio. ValMark and its representatives are in compliance with the current registration and notice filing requirements imposed upon federally covered investment advisers by those states in which ValMark maintains clients. For registration or additional information about ValMark, including its services and fees, a copy of our Form ADV is available upon request by contacting ValMark at 1-800-765-5201. This article provides commentary on current economic and market conditions and is not directly relevant to any particular client account. The information contained herein should not be construed as personalized investment advice or recommendations to buy or sell any security. There can be no assurance that the views and opinions expressed in this article will come to pass. Investing involves the risk of loss, including the loss of principal. Past performance is no guarantee of future results. Information contained herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Indexes are unmanaged and cannot be directly invested in. TOPS® is a registered trademark of ValMark Advisers, Inc. Diversification does not prevent or guarantee against loss.