Quantcast

Triple net returns and the importance of taxes

A few weeks ago we talked about how even a relatively benign, by headline standards, inflation environment inflation is a “silent killer” of investment portfolios.  The second constant for investors that is rarely written about is taxes.  Taxes are not a sexy topic for bloggers or for the financial media.  One reason why is that a big part of the investment universe is filled with investors like endowments and pension funds that don’t have to worry about taxes.  The second reason is that taxes, unlike market trends and themes, don’t change all that much.  Therefore the media pays attention to the squiggle of market prices more than the laws coming out of Washington.

However one can argue, like the Turnkey Analyst did in a post earlier this year that taxes are a much more important lever to pull for taxable investors than alpha.  This is due in part to the fact that taxes are are a more predictable source of returns than alpha ever can be.  Another way in which the issue of taxes comes up for individuals has to do with collective investment vehicles like mutual funds and ETFs.

One of the big arguments for ETFs has been their more efficient way of dealing with taxes.  Over time ETFs have consistently paid out less in the way of capital gains distributions than their mutual fund cousins.  The chart below via Meb Faber and iShares shows the tax cost to various actively managed mutual categories over the past decade.  For taxable investors the drag of taxes on returns can add up to 2.0% per year.  In a world of o% interest rates this detriment to returns can really add up.