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Article

Tax-Adjusted Portfolio Optimization and Asset Location: Extensions and Synthesis

Stephen M. Horan and Ashraf Al Zaman
The Journal of Wealth Management Winter 2008, 11 (3) 56-73; DOI: https://doi.org/10.3905/jwm.2008.11.3.056
Stephen M. Horan
is head of private wealth at CFA Institute in Charlottesville, VA.
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  • For correspondence: stephen.horan@cfainstitute.org
Ashraf Al Zaman
is an assistant professor of finance at the Sobey School of Business, Saint Mary’s University in Halifax, Canada.
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  • For correspondence: ashraf.zaman@smu.ca
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Abstract

Models developed in a pretax framework do not necessarily apply in an after-tax framework, and this notion certainly applies to portfolio optimization. This article derives generalized tax adjustments to return and volatility inputs in an after-tax portfolio optimization algorithm. It extends the literature by incorporating an asset’s cost basis, addressing a broader array of taxable entities, and deriving expressions for off-diagonal terms in the covariance matrix. They develop a comprehensive framework that distinguishes between tax-adjustments predicated on pretax market values and after-tax values. The distinction is important so that portfolio managers can avoid inadvertently blending two inconsistent approaches.

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The Journal of Wealth Management
Vol. 11, Issue 3
Winter 2008
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Tax-Adjusted Portfolio Optimization and Asset Location: Extensions and Synthesis
Stephen M. Horan, Ashraf Al Zaman
The Journal of Wealth Management Oct 2008, 11 (3) 56-73; DOI: 10.3905/jwm.2008.11.3.056

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Tax-Adjusted Portfolio Optimization and Asset Location: Extensions and Synthesis
Stephen M. Horan, Ashraf Al Zaman
The Journal of Wealth Management Oct 2008, 11 (3) 56-73; DOI: 10.3905/jwm.2008.11.3.056
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  • Article
    • Abstract
    • AFTER-TAX ASSET VALUATION
    • CLASSICAL OPTIMIZATION FOR THE TAXABLE INVESTOR
    • AN EXAMPLE
    • CONCLUSION
    • APPENDIX
    • ENDNOTES
    • REFERENCES
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