Minimize Taxes to Maximize Your Investment Return

Here are some thoughts from the wonderful book The Bogleheads' Guide to Investing (I LOVED the book -- see my rating for details) on how taxes play a big role in determining the performance of your investment portfolio.

They start by recognizing that costs matter if you want to maximize your investment returns. They then note that the biggest costs of all -- and ones you must control if you want to maximize your return -- are taxes. Then they review three studies that show the dramatic impact taxes have on total investment returns. Here are summaries of the studies they cite:

• A high-bracket taxpayer who invested $1.00 in U.S. stocks would have $21.89 at the end of the study period (30-year term) in a tax-deferred account. If it had been a taxable account, the $1.00 would have only been $9.87.

• Over a 10-year period, The Lipper Company found that the average stock fund surrendered approximately 23.5% of its load-adjusted return to taxes.

• Over a 15-year period, the average mutual fund shareholder had an average annualized pretax return of 10.0%. However, after federal taxes, that 10.0% return was reduced to 7.7% -- a reduction of 23 percent.

Yikes! What a big bite taxes can take! This is the reason I try to get as much money in tax-advantaged accounts as possible (401k, IRA, etc.) My biggest problem in this effort is that I have more money to invest than what I can shelter from taxes -- hence I have a good amount that's subject to taxes each and every year.

In the next chapter, the book lists 13 tax-reducing ideas. Here are my favorites:

• Use tax-advantaged accounts.
• Use taxable accounts for short-term goals.
• Use index or tax-managed funds in taxable accounts.
• Keep turnover low.
• Place funds for maximum after-tax return.

Honestly, I think I could do a lot better in this area. Though I have a good amount invested in index funds, I do own other funds that I'm sure aren't very tax-advantaged. I'm adding them to my list for replacing next year.

For more thoughts on investing, see Best of Free Money Finance: Investment Posts.

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[Nouveau Riche]

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