Applying After-Tax Asset Allocation

Abstract

The notion of after-tax asset allocation is gaining acceptance among private wealth managers. This article presents practical methods of calculating an investor's after-tax asset allocation, particularly as it relates to taxable accounts. The after-tax value of a taxable account can be substantially less than its stated pretax value, especially for long time horizons. Interestingly, after-tax values of taxable accounts are relatively insensitive to the investment's systematic risk but inversely related to the investment's tax burden and the risk-free rate. These results highlight the importance of converting balances in taxable accounts to after-tax values—a practice which heretofore has been dismissed by scholars and practitioners.

TOPICS: Wealth management, portfolio construction, risk management, performance measurement