Why is tax management important?
The simple answer: taxes have the ability to seriously erode returns.
According to Morningstar, as a whole, U.S. equity funds (active, passive, ETFs) gave up 2% of returns to taxes for the three-year period ending March 2019. That means a mutual fund with a 10% pre-tax, three-year annualized return actually had a return of only 8% on an after-tax basis. This loss of return (“tax drag”) of 2% is really a hidden expense ratio that can have a material impact on the long-term growth of a portfolio.
The good news is that Russell Investments’ expertise in tax-managed investing can help – and the proof is in our results. For the same three-year period, while providing consistent pre-tax returns, our Tax-Managed U.S. Large Cap Fund (Class S) gave up only 0.27% to taxes, while our Tax-Managed U.S. Mid & Small Cap Fund (Class S) surrendered just 0.04%.
Our tax-managed equity funds vs. peer group
Average annual tax drag for 3 years ending March 31, 2019
Please hover over the Russell Investment bar to see which Russell Investment product was evaluated relative to the peer group. View fund performance and prices.
Performance quoted represents past performance and should not be viewed as a guarantee of future results. The investment return and principal value of an investment will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. Current to the most recent month-end performance data may be obtained by visiting https://russellinvestments.com.
Morningstar Categories included: US Large Blend, US Small Blend, Non-U.S. Equity = 25% Diversified Emerging Markets / 75% Foreign Large Blend, See appendix at end of presentation for methodology. Average of Morningstar’s Tax Cost Ratio for universes as defined. Passive is defined as being an index fund as reported by Morningstar or part of an ETF Category.
Did you know?
of taxable investments are invested in open-end mutual funds.
That’s why we believe tax-managed investing is an opportunity many investors can’t afford to ignore.
*Source: 2019 ICI Factbook
The potential impact of taxes on investors' wealth.
With a hypothetical view, you can see how reducing tax drag can impact an investor’s ending wealth. Consider the hypothetical growth of a $500k portfolio over 10 years at a 7.5% return each year. If the portfolio’s pre-tax return had a 2% tax drag, that portfolio would have an ending value of just over $850k. With no tax drag, that portfolio would have an ending value of $1 million.
Hypothetical growth of $500,000 over 10 years at 7.5% per year
10 year hypothetical impact of taxes assumed annual return of 7.5%
Note: This is a hypothetical illustration and not meant to represent an actual investment strategy. Taxes may be due at some point in the future and tax rates may be different when they are. Investing involves risk and you may incur a profit or loss regardless of strategy selected.
How we manage for taxes.
We've been helping investors increase their after-tax returns for more than three decades. And we continue to invest in the capability.
Here's how we do it:
With a trading desk staffed 24 hours a day by traders averaging more than 15 years of experience across the investment spectrum, we can precisely sell securities that underperform in order to offset a taxable gain. And instead of waiting for year end, we harvest tax losses all year long.
Minimize wash sales
The benefits of tax-loss harvesting can be negated when sold securities are repurchased within 30 days. Our total portfolio approach can help minimize wash sales.
Monitoring holding periods
Under current U.S. IRS rules, selling investments prior to holding them for over one year will generate short-term gains, which are taxed at the Federal level as ordinary income. We monitor holding periods because, in general, the fewer short-term gains, the greater the after-tax return.
Deferring realized gains
Deferring capital gains taxes now allows returns to potentially keep compounding on a potentially higher base. Keep in mind that taxes will likely be due at some point and tax rates could be higher once they are due.
Depending on an investor’s individual situation, capital gains taxes are typically only paid when an investment is sold at a gain. That’s why our tax-managed approach works to reduce turnover within a portfolio.
We take tax management even further by carefully managing individual securities, strategically grouping securities into lots, precisely managing portfolio yield, and holistically directing the underlying tax-specialist managers in a portfolio.
> 75% potential tax drag reduction*
*Russell Investments’ tax-managed approach may potentially reduce tax drag by more than 75%, over other actively-managed U.S. equity mutual funds.
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What is tax-managed investing?
Tax-managed investing is an approach designed to help tax-sensitive investors by seeking to minimize tax drag and maximize after-tax returns. This is typically accomplished by decreasing capital gains or dividends.
Of course, investments in a 401(k) or an IRA are typically tax-deferred. But for those who invest beyond tax-deferred vehicles, taxes have the ability to seriously erode investment returns.
For investors looking to keep more of their investment earnings, the decision to include tax-managed solutions may help. Tax-exempt bond funds, tax-managed mutual funds and tax-managed model strategies are designed to reduce the amount lost to taxes each year.
Why worry about capital gains?
Capital gains sound great. A gain means money was earned, right? But capital gains come with tax burdens. Inside of a tax-sensitive mutual fund, whenever the fund sells stocks or bonds that have a gain, that capital gain must be passed along to the investor as a shareholder of the fund. And capital gain distributions are something that investors often don’t pay attention to until year-end statements and 1099-DIV forms hit their mailboxes.
In simplest terms, a tax-managed investment approach can help minimize the amount of capital gains all year long. This means tax-managed investing can also minimize the size of the tax bill and let investors keep a bigger piece of the investment return.
What are after-tax returns?
After-tax returns are the returns on an investment that remain after taxes are subtracted. For any investment that is vulnerable to taxes, think of after-tax returns as the actual amount earned, once taxes are paid.
For example, let’s say an investor made a $1000 return on an investment, but, because of their tax bracket, had to pay 30% in taxes. Their overall return may have been $1000, but their after-tax return was only $700.
All investments have different tax exposures. Some funds have high before-tax returns, but low after-tax returns. Unless investors are in favor of giving more of their returns to the government, we believe that the after-tax return amount is the number investors should focus on. That’s why we focus so much energy and expertise on tax-managed investing.
Fund objectives, risks, charges and expenses should be carefully considered before investing. A summary prospectus, if available, or a prospectus containing this and other important information can be obtained by calling 800-787-7354 or by visiting the prospectus and reports page to download one. Please read the prospectus carefully before investing.