Pre-tax returns are theoretical. After-tax returns are what investors keep. A strategy returning 15% pre-tax but incurring heavy short-term capital gains taxes may net only 10% after-tax. Tax-efficient investing focuses on after-tax returns, the only returns that matter to individuals.
Tax-Loss Harvesting
Tax-loss harvesting sells losing positions to realize losses, offsetting gains elsewhere. A realized 5% loss can offset 5% gains, creating no net taxable income. The proceeds are reinvested in similar (not identical) positions to maintain exposure.
Wash sale rules prevent claiming losses on substantially identical replacements within 30 days. Creative use of similar instruments (different fund family, different sector index) maintains exposure while satisfying wash sale requirements.
Turnover Management
High turnover generates short-term capital gains taxed as ordinary income (up to 37% federal rates). Long-term capital gains are taxed at lower rates (up to 20%). Holding periods matter greatly. A strategy with 50% annual turnover faces heavy tax drag.
Strategic rebalancing timing minimizes tax impact. Rebalance using new contributions when possible. When selling appreciated positions, sell oldest lots first to maximize holding periods. Disciplined lot tracking improves tax efficiency.
Asset Location Strategy
Tax-deferred accounts (401k, IRA) shouldn't hold tax-efficient index funds; they should hold high-turnover active strategies since taxes don't matter. Taxable accounts should hold tax-efficient index funds; active strategies face too much tax drag.
Placing tax-inefficient bonds in tax-deferred accounts preserves return; placing them in taxable accounts generates ordinary income taxes. Strategic asset location optimizes after-tax returns across all accounts.
Dividend and Income Timing
Buying dividend-paying stocks right before ex-dividend dates can be tax-inefficient for short-term holders. Long-term dividend treatment requires holding periods. Qualified dividend rates (15-20%) beat non-qualified rates (ordinary income). Timing stock purchases around dividend dates matters.
Alternative Structures
Municipal bonds provide tax-free income in taxable accounts. Tax-managed funds minimize distributions. Some strategies deliberately harvest losses to offset gains. Charitable donations of appreciated securities (instead of selling) avoid capital gains entirely.
Educational content only. Not investment advice.