RT Journal Article
SR Electronic
T1 Embedded Tax Liabilities and Portfolio Choice
JF The Journal of Portfolio Management
FD Institutional Investor Journals
SP 93
OP 101
DO 10.3905/jpm.2013.39.3.093
VO 39
IS 3
A1 Phillip A. Turvey
A1 Anup K. Basu
A1 Peter Verhoeven
YR 2013
UL https://pm-research.com/content/39/3/93.abstract
AB Taxes play an important role in determining after-tax investment risk and returns, but many practitioners still make investment decisions based on pre-tax values. The apparent complexity of dealing with deferred capital gains and the question of how these implied future tax liabilities should be valued are central to this problem. The authors use a simple arbitrage argument to show that a risk-free discount rate is appropriate for calculating the present value of future tax liabilities. This lets analysts adjust risk and returns for effective tax rates and present a more accurate picture to the investor. The results show a taxation-induced preference for holding equities over bonds and a location preference for holding equities in a taxable account and bonds in retirement accounts. These important findings contrast with traditional investment advice that suggests a greater capacity for risk in retirement accounts.TOPICS: Portfolio construction, analysis of individual factors/risk premia, statistical methods