Tax Planning and Greater Returns

Tax planning is the biggest over looked area when it comes to individual investing.  Many advisors are so busy chasing returns that they lose sight of the things that they can actually control to help boost your returns.  Let’s first talk about turnover ratio in your mutual funds.  Turnover ratio is the amount of buying and selling that is going on within your fund in a year’s time.  It seems that the average turnover ratio within many funds that we see out there is around 94%.  So for example if your fund has 100 stocks and the manager sells 94 of the stocks within a year and buys a new 94 within a year that is 94% turnover ratio.  So we may ask people why would it be important to know this?  The most common response back that we get is because of the fees of buying and selling.  This is true because the excess fees will eat into your return.  But if we are talking about taxes if the manager does a lot of buying and selling within a year you are now talking about short term gains instead of long term gains.  So you might be taxed at a 30 to 50 percent higher tax rate on your funds just due to high turnover ratio not to mention the extra fees and possible commissions.

HIFO & FIFO Treatment

What we are referring to is a tax treatment Highest in first out versus First in first out treatment.  Let’s say some years ago you bought XYZ stock at $5 a share then you bought some more later at $10 dollars a share and finally you bought more at $15 a share over time.  Now you want to sell some of the shares you currently have, What shares do you want to sell in order to pay the least amount of capital gains tax?  Obviously  you would want to sell the $15 shares first to pay the least amount of capital gains.  That would be using the highest in first out method.  Most of the time clients are using whatever default method the brokerage firm uses with no thought to tax treatment when selling stocks.  Uncle Sam allows you to use other cost base methods as well with your funds and stocks.  So you could use one cost base method on one fund and a different cost base method on another depending upon what you and your advisor are trying to accomplish tax wise.  With proper tax planning you can increase your returns without taking on any additional risk.