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The Performance Reporting Trap

 

The tables below illustrate three important points.

1. Tax efficiency is a critical factor in portfolio decisions and management.

2. Published reporting of returns materially distorts actual returns because withdrawals from a folio are not counted in the performance reporting.

3. It is difficult for institutional managers of large cap funds to outperform the S&P 500 Index.

 

TAX EFFICIENT PORTFOLIO
5% Per year Turnover

 
Assumed
Rates
Year 1
Year 2
Year 3
Year 4
Year 5
Beginning value   10,000,000 10,807,500 11,680,206 12,623,382 13,642,720
Annual Portfolio Return 10% 1,000,000 1,080,750 1,168,021 1,262,338 1,364,272
Annual Portfolio Turnover 5% 550,000 594,413 642,411 694.286 750,350
Tax Rate Paid Annually -35% -192,500 -208,044 -224,844 -243,000 -262,622
Ending Value   10,807,500 11,680,206 12,623,382 13,642,720 14,744,370
Reported Return 10.00% Assumes zero cost basis portfolio, taxes paid on portfolio turnover only
After Tax Return 8.08%
*Returns are annual compound returns

 

TAX INEFFICIENT PORTFOLIO
20% Per year Turnover

 
Assumed
Rates
Year 1
Year 2
Year 3
Year 4
Year 5
Beginning value   10,000,000 10,695,000 11,438,303 12,233,265 13,083,476
Annual Portfolio Return 15% 1,500,000 1,604,250 1,715,745 1,834,990 1,962,521
Annual Portfolio Turnover 20% 2,300,000 2,459,850 2,630,810 2,813,651 3,009,200
Tax Rate Paid Annually -35% -805,000 -860,948 -920,783 -984,778 -1,053,220
Ending Value   10,695,000 11,438,303 12,233,265 13,083,476 13,992,778
Reported Return 15.00% Assumes zero cost basis portfolio, taxes paid on portfolio turnover only
After Tax Return 6.95%
*Returns are annual compound returns

 


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