How To Beat Taxes And Fees (when investing)

Larry Light for Forbes writes: They’re like mold to your investments: taxes and fees that rot your returns. Nathan Sonnenberg, chief investment officer at Glassman Wealth Services, in McLean, Va., is very smart about ways to beat them. Here’s his report:

Taxes and fees in your portfolio add up, quickly whittling your returns, eroding the cash you hold and harming your future. Making your investments work best for you means heading off your potential tax exposure and high management fees, and managing your portfolio to take every advantage.

Do-it-yourself investors and even some financial advisors often ignore those expenses, placing too much attention into structuring a portfolio and not enough into low-hanging opportunities, such as keeping expenses low. Portfolio tax efficiency translates into how much of your gains you keep after fees and taxes. The greater the tax efficiency, the more gains you keep – like the difference between gross pre-tax earnings and net earnings after taxes on your paycheck.

For example, one avenue of exposure to the equity markets is a Standard & Poor’s 500 Index mutual fund. While its low fees are important, the tax efficiency of the index affects your after-tax returns more. The S&P 500 Index has low turnover, less than 5% of the listed companies per year on average.

This means the index adds or removes about 5% of the total value of S&P 500 companies yearly – in stark contrast to how most money managers invest.
On average, U.S. equity managers turn over their complete portfolio once every two years. This buying and selling of securities creates taxable gains on your holdings.
You can take several steps to improve the tax efficiency of your portfolio.
Indexing. Do you want to keep 11.3% or 9.6% of your returns? That’s the after-tax difference between the Vanguard S&P 500 Index (VSPVX) and the average U.S. large-cap equity fund over the past three years. What accounts for the difference?

Fees and tax efficiency: The annual index fund fee is 0.17%, the average U.S. equity manager fee 1.03%. More important, the turnover of stocks in active manager portfolios was 10 times greater than that of the index. All that trading erodes returns.

Note: I don’t advocate putting every investment in an index fund. Our firm certainly uses managed funds in many areas of portfolios where those funds make sense. Instead, I suggest that, in certain asset categories, you index for efficiency and use active managers for other segments of the markets. [snip].  The article continues at Forbes, click here to continue reading.....