As Biden administration seeks to increase capital gains, seek tax efficiency

OOctober is not only the scary season, it is also the season of tax efficiency. With rate hikes being a separate possibility as the Biden administration ends capital gains, advisers must consider the tax efficiency of their clients’ portfolios.

In a white paper by T. Rowe Price, portfolio construction specialist Terry Davis and portfolio construction analyst John Gray write: “One of the great advantages of the current US tax code is its treatment of municipal bonds. . taxes at the federal level (and even at the state and local level as well, if you live in the issuing state). “

In most categories, taxable bonds top the pre-tax returns, but municipal bonds perform better after tax. Certain categories of taxable bonds, such as high yield, are particularly ineffective. Municipal bonds also have the advantage of having a low correlation with stocks. Correlation measures the degree to which securities move in tandem, so a lower correlation indicates greater diversification.

Finding tax efficiency in equity

Finding the tax efficiency of stocks can be daunting compared to fixed income, but stock strategies can still be effective. Davis and Gray point out that “when constructing the equity portion of a tax-efficient investment model, vehicles such as ETFs and SMAs are typically used. The ETF envelope tends to create fewer taxable events and only sell holdings when they increase their index and rebalance. Davis and Gray go on to note that active mutual funds can also be a great option for adding tax-efficient alpha to a portfolio.

In addition, long-term capital gain through dividends is also an effective model. Therefore, a low turnover strategy focused on dividends is a strong game that can mitigate the impact of taxes on returns. T. Rowe Price offers several ETFs that are both tax and economic. On the equity side, they have funds like T. Rowe Price Blue Chip Growth ETF (TCHP), the T. Rowe Price Growth Equity ETF (TGRW), and the T. Rowe Price Dividend Growth ETF (TDVG). They also have a number of fixed income ETFs, such as the T. Rowe Price QM US Bond ETF (TAGG).

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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