Author Topic: The Impact of Taxes on Investor Returns  (Read 5594 times)

AdrianC

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The Impact of Taxes on Investor Returns
« on: February 03, 2016, 05:38:05 AM »
Interesting article on the impact of taxes for the buy and hold investor:

http://www.philosophicaleconomics.com/2015/12/taxes/

Pooplips

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Re: The Impact of Taxes on Investor Returns
« Reply #1 on: February 03, 2016, 05:51:25 AM »
I have never heard of that blog but that is a really interesting article. It explains the downward pressure on dividends and the increase in buybacks.

Wile E. Coyote

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Re: The Impact of Taxes on Investor Returns
« Reply #2 on: February 03, 2016, 05:57:13 AM »
Unless I missed it, the article seems to gloss over the impact that reinvesting dividends will have on your cost basis in the stock which will reduce capital gains on a later sale. It is an interesting article, but it would be better if it addressed the full tax impact. 

NoStacheOhio

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Re: The Impact of Taxes on Investor Returns
« Reply #3 on: February 03, 2016, 10:38:46 AM »
Tangentially, this is the first coherent, non-hair-on-fire argument I've seen against stocks being overvalued (Shiller P/E, etc).

Also, obsessing over taxes to the point that you're not investing or investing drastically differently than you would seems a little silly. Investing in stocks is still a pretty good way to go no matter how you slice it.

PhysicianOnFIRE

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Re: The Impact of Taxes on Investor Returns
« Reply #4 on: February 03, 2016, 11:07:54 AM »
I would love to have an index fund in my taxable account that paid no dividends.  Owning Vanguard Total Stock Market and S&P 500 with about a 2% qualified dividend that is taxed at about 28% results in a tax drag of 56 basis points.  A 7% return is lowed to 6.44%.  It's not huge, but it's real. 

protostache

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Re: The Impact of Taxes on Investor Returns
« Reply #5 on: February 03, 2016, 02:08:52 PM »
I would love to have an index fund in my taxable account that paid no dividends.  Owning Vanguard Total Stock Market and S&P 500 with about a 2% qualified dividend that is taxed at about 28% results in a tax drag of 56 basis points.  A 7% return is lowed to 6.44%.  It's not huge, but it's real.

28% meaning you're in the 20% capital gains bracket? Or do you live in a place with high state/local taxes?

johnny847

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Re: The Impact of Taxes on Investor Returns
« Reply #6 on: February 03, 2016, 02:32:48 PM »
I would love to have an index fund in my taxable account that paid no dividends.  Owning Vanguard Total Stock Market and S&P 500 with about a 2% qualified dividend that is taxed at about 28% results in a tax drag of 56 basis points.  A 7% return is lowed to 6.44%.  It's not huge, but it's real.

I would too, but only if the fund's return through capital appreciation was comparable to the pre tax total return (or better) of a total stock market fund, which is what I believe you meant.

PhysicianOnFIRE

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Re: The Impact of Taxes on Investor Returns
« Reply #7 on: February 03, 2016, 04:35:54 PM »
I would love to have an index fund in my taxable account that paid no dividends.  Owning Vanguard Total Stock Market and S&P 500 with about a 2% qualified dividend that is taxed at about 28% results in a tax drag of 56 basis points.  A 7% return is lowed to 6.44%.  It's not huge, but it's real.

28% meaning you're in the 20% capital gains bracket? Or do you live in a place with high state/local taxes?

In the 15% for LTCG / qualified dividends, but also pay the 3.8% medicare surtax plus high state income tax on them.  #firstworldproblem due to high income.  It's a temporary problem with an easy solution (RE).

mrpercentage

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Re: The Impact of Taxes on Investor Returns
« Reply #8 on: February 03, 2016, 05:34:22 PM »
In a perfect world we wouldn't have any taxes. Taxes on your money in general is a high quality problem.

I read somewhere that 70% of the S&P return is dividend reinvestment. So if you were in a taxable account (0.70[return of stock] x0.15[dividend rate])= 10.5% long term drag. Thats presuming 70% of the return is reinvested dividends. This doesn't exactly reflect reality because I do not have taxes with held from dividends, so it just hits my tax return instead. My investment marches on like normal. I invest in taxable despite not maxing out tax deferred. I am aware of the issue and math though. I still love dividends. Cheers

AdrianC

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Re: The Impact of Taxes on Investor Returns
« Reply #9 on: February 03, 2016, 05:53:37 PM »
I would love to have an index fund in my taxable account that paid no dividends.  Owning Vanguard Total Stock Market and S&P 500 with about a 2% qualified dividend that is taxed at about 28% results in a tax drag of 56 basis points.  A 7% return is lowed to 6.44%.  It's not huge, but it's real.

The article gave the answer - Berkshire :-)

(which is, in my estimation, very cheap right now).

mrpercentage

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Re: The Impact of Taxes on Investor Returns
« Reply #10 on: February 03, 2016, 07:01:41 PM »
I would love to have an index fund in my taxable account that paid no dividends.  Owning Vanguard Total Stock Market and S&P 500 with about a 2% qualified dividend that is taxed at about 28% results in a tax drag of 56 basis points.  A 7% return is lowed to 6.44%.  It's not huge, but it's real.

The article gave the answer - Berkshire :-)

(which is, in my estimation, very cheap right now).

Berkshire has great diversification. It is its own mutual fund. There are a handful of good companies to do it with. Alphabet, Amazon, Salesforce, etc. Expect a rollercoaster though. Berk probably is the most stable non-dividend stock out there. The funny thing is Berk's portfolio is all privately held companies or dividend paying stocks. Warren likes dividends he just doesn't like sharing them.

johnny847

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Re: The Impact of Taxes on Investor Returns
« Reply #11 on: February 03, 2016, 09:38:46 PM »
In a perfect world we wouldn't have any taxes. Taxes on your money in general is a high quality problem.

I wholeheartedly disagree with you there. Without taxes there is no government.

JZinCO

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Re: The Impact of Taxes on Investor Returns
« Reply #12 on: February 03, 2016, 09:45:50 PM »
In a perfect world we wouldn't have any taxes. Taxes on your money in general is a high quality problem.

I wholeheartedly disagree with you there. Without taxes there is no government.
I think MrPercentage knows that :)

Snark aside, I knew as soon as I read that line that this thread was going to get derailed. and I'm not helping any either.

nobodyspecial

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Re: The Impact of Taxes on Investor Returns
« Reply #13 on: February 03, 2016, 10:43:03 PM »
Berkshire has great diversification. It is its own mutual fund. There are a handful of good companies to do it with. Alphabet, Amazon, Salesforce, etc. Expect a rollercoaster though. Berk probably is the most stable non-dividend stock out there.
I always wondered why people didn't just own Berkshire or Fairfax Financial if it always beats the market?
Is it the risk that they will drop through the floor the moment Buffet or Watsa die?

Is there a mutual fund that lets you buy fractions of a Berkshire share?

Pooplips

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Re: The Impact of Taxes on Investor Returns
« Reply #14 on: February 04, 2016, 05:08:05 AM »
Berkshire has great diversification. It is its own mutual fund. There are a handful of good companies to do it with. Alphabet, Amazon, Salesforce, etc. Expect a rollercoaster though. Berk probably is the most stable non-dividend stock out there.
I always wondered why people didn't just own Berkshire or Fairfax Financial if it always beats the market?
Is it the risk that they will drop through the floor the moment Buffet or Watsa die?

Is there a mutual fund that lets you buy fractions of a Berkshire share?

BRK.B

AdrianC

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Re: The Impact of Taxes on Investor Returns
« Reply #15 on: February 04, 2016, 08:18:38 AM »
Warren likes dividends he just doesn't like sharing them.

Berkshire is a great way to do tax efficient large-cap investing, IMHO.

I don't want him to pay any dividends. I want him to keep on allocating capital while he still has his marbles. When he's gone his successor can buy back shares.

If I need income from Berkshire I'll just sell a few shares.

AdrianC

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Re: The Impact of Taxes on Investor Returns
« Reply #16 on: February 04, 2016, 08:25:23 AM »
I always wondered why people didn't just own Berkshire or Fairfax Financial if it always beats the market?
Is it the risk that they will drop through the floor the moment Buffet or Watsa die?

Is there a mutual fund that lets you buy fractions of a Berkshire share?

Berkshire doesn't always beat the market and size is a huge anchor. Succession is a concern. It's all "old economy" stuff. Lots of things for Mr. Market to worry about.

mrpercentage

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Re: The Impact of Taxes on Investor Returns
« Reply #17 on: February 04, 2016, 08:26:03 AM »


Is there a mutual fund that lets you buy fractions of a Berkshire share?

the XLF... its the biggest holding in the financial sector. Hence you could benefit buying now because that whole sector is down big and this sort of ETF is compressing the perfectly good BRK.B. That means buy now

Rubic

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Re: The Impact of Taxes on Investor Returns
« Reply #18 on: February 04, 2016, 09:24:25 AM »
The article gave the answer - Berkshire :-)

(which is, in my estimation, very cheap right now).

In relationship to Book Value, the market price of Berkshire hasn't been this cheap since 2011.  Yesterday I believe it briefly touched Buffett's buy-back threshold (1.2x BV).

Rubic

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Re: The Impact of Taxes on Investor Returns
« Reply #19 on: February 04, 2016, 09:40:53 AM »
Warren likes dividends he just doesn't like sharing them.

Berkshire is a great way to do tax efficient large-cap investing, IMHO.

I don't want him to pay any dividends. I want him to keep on allocating capital while he still has his marbles. When he's gone his successor can buy back shares.

If I need income from Berkshire I'll just sell a few shares.

Agreed.

Under the current long-term capital gains structure, I could FIRE today and sell $40K+ of Berkshire per year -- tax-free from from taxable accounts, without ever touching my IRA.

https://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United_States

Or, at least until age 70, when I'll be collecting Social Security and have to deal with RMD on my traditional IRA ... but that's a discussion for another thread.

Rubic

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Re: The Impact of Taxes on Investor Returns
« Reply #20 on: February 04, 2016, 10:03:22 AM »
I always wondered why people didn't just own Berkshire or Fairfax Financial if it always beats the market?

Just because Berkshire has beaten the market in the past is no guarantee it will continue to do so in the future.  In fact it's a mathematical certainty that Berkshire can't continue to outperform the market indefinitely, because at some point it becomes the market.  As AdrianC has mentioned above, Berkshire's enormous size acts as huge anchor on its ability to grow.  It requires an acquisition of company such as BNSF or PCP to barely move the needle, and there aren't many companies of those sizes left in the universe.

That said, at today's prices I think it's likely Berkshire will outperform the market over the next decade.  (NOT a stock recommendation, btw.)

Quote
Is it the risk that they will drop through the floor the moment Buffet or Watsa die?

Buffett has been planning for this certain event for at least 30 years.  Most people expect the market price to dip briefly when this occurs.  His co-chairman, Charlie Munger, has made a statement to the effect that "I hope none of my heirs will be so stupid as to sell their Berkshire stock."

Quote
Is there a mutual fund that lets you buy fractions of a Berkshire share?

The 'B' shares were specifically created because some companies were selling (at high commissions) fractions of BRK/A, trading off of Berkshire's reputation.  For the retail investor, there's virtually no difference in buying A or B shares.

AdrianC

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Re: The Impact of Taxes on Investor Returns
« Reply #21 on: February 04, 2016, 11:32:01 AM »
Under the current long-term capital gains structure, I could FIRE today and sell $40K+ of Berkshire per year -- tax-free from from taxable accounts, without ever touching my IRA.

Indeed. That's my plan, when I need it.

Right now I just keep buying it...I might be an addict.

Rubic

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Re: The Impact of Taxes on Investor Returns
« Reply #22 on: February 04, 2016, 12:02:55 PM »
Under the current long-term capital gains structure, I could FIRE today and sell $40K+ of Berkshire per year -- tax-free from from taxable accounts, without ever touching my IRA.

Indeed. That's my plan, when I need it.

Right now I just keep buying it...I might be an addict.

I'm sure you're aware, but for the benefit anyone else following our topic detour, there's no guarantee that Berkshire will never offer a dividend.  Even with the buy-back policy in place, there's a non-zero chance (post-Buffett) Berkshire will throw off so much cash with so few acquisition opportunities that its managers will be compelled to offer a dividend -- assuming they can't buy back enough Berkshire stock at a reasonable price.

I'm hoping -- but not predicting -- that day is deferred until far into the future.

Scandium

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Re: The Impact of Taxes on Investor Returns
« Reply #23 on: February 05, 2016, 07:05:15 AM »
Under the current long-term capital gains structure, I could FIRE today and sell $40K+ of Berkshire per year -- tax-free from from taxable accounts, without ever touching my IRA.

Indeed. That's my plan, when I need it.

Right now I just keep buying it...I might be an addict.

I'm sure you're aware, but for the benefit anyone else following our topic detour, there's no guarantee that Berkshire will never offer a dividend.  Even with the buy-back policy in place, there's a non-zero chance (post-Buffett) Berkshire will throw off so much cash with so few acquisition opportunities that its managers will be compelled to offer a dividend -- assuming they can't buy back enough Berkshire stock at a reasonable price.

I'm hoping -- but not predicting -- that day is deferred until far into the future.

Interesting thought: what would happen to the share price then? Would the people who bought it for its lack of dividend sell, or would the "OMG dividend!" crowd suddenly start buying BRK and it would go up? Could go either way. The latter would of course be great if you don't want dividends and sell it off.

protostache

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Re: The Impact of Taxes on Investor Returns
« Reply #24 on: February 05, 2016, 07:25:23 AM »
The 'B' shares were specifically created because some companies were selling (at high commissions) fractions of BRK/A, trading off of Berkshire's reputation.  For the retail investor, there's virtually no difference in buying A or B shares.

Before 2010 BRK.B was still about $3,300 per share. The reason why the B shares are actually in the realm of retail investors is because Buffett split them in 2010 prior to the BNSF acquisition. $10B of the $25B purchase price was funded by issuing new shares, and many BNSF shareholders elected to receive B-shares. Conveniently, it also make Berkshire eligible for the S&P 500 at the same time.
« Last Edit: February 05, 2016, 07:27:04 AM by protostache »

Rubic

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Re: The Impact of Taxes on Investor Returns
« Reply #25 on: February 05, 2016, 08:58:26 AM »
The 'B' shares were specifically created because some companies were selling (at high commissions) fractions of BRK/A, trading off of Berkshire's reputation.  For the retail investor, there's virtually no difference in buying A or B shares.

Before 2010 BRK.B was still about $3,300 per share. The reason why the B shares are actually in the realm of retail investors is because Buffett split them in 2010 prior to the BNSF acquisition. $10B of the $25B purchase price was funded by issuing new shares, and many BNSF shareholders elected to receive B-shares. Conveniently, it also make Berkshire eligible for the S&P 500 at the same time.

Correct, but when the B shares were first issued in 1996 they were priced at 1/30th the value of an A share, affordable by most retail investors and a better deal than the unit trusts.  In 2010 the B shares were split again (50-to-1) so the smaller BNSF shareholders got a fair deal.

Edit: minor typo
« Last Edit: February 05, 2016, 09:32:34 AM by rubic »

JetBlast

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Re: The Impact of Taxes on Investor Returns
« Reply #26 on: February 05, 2016, 09:04:40 AM »
Very interesting read. Thanks for sharing AdrianC