TY - JOUR T1 - Diversification in the Presence of Taxes JF - The Journal of Portfolio Management SP - 61 LP - 71 DO - 10.3905/jpm.2000.319784 VL - 27 IS - 1 AU - David M. Stein AU - Andrew F. Siegel AU - Premkumar Narasimhan AU - Charles E. Appeadu Y1 - 2000/10/31 UR - https://pm-research.com/content/27/1/61.abstract N2 - A common problem for taxable investors is how much to diversify either a low cost basis single–asset or concentrated portfolio. While tax–exempt theory is clear on the benefits of diversification, and there are useful industry methods for addressing this, in the presence of taxes there are no standard approaches to arriving at a considered choice. The authors propose an analytic and intuitive framework for addressing the problem, considering only two investment alternatives. By defining a tax–deferred equivalent of the taxable investor, they are able to adapt standard analytical methods and view the diversification decision in the presence of taxes as a conventional risk–return trade–off, provided the appropriate tax–deferred performance measures are used. Greater diversification is needed with greater initial asset volatility, with longer investment horizons, with lower expected return of the initial asset, and with a higher cost basis. Less diversification is needed when the investor receives a step–up in basis at the horizon. The results highlight the substantial risks incurred in concentrated holdings and often support high levels of diversification, even in the face of taxes. ER -