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Refining After-Tax Return and Risk Parameters

Peter Mladina
The Journal of Wealth Management Fall 2020, 23 (2) 8-17; DOI: https://doi.org/10.3905/jwm.2020.1.112
Peter Mladina
is director of portfolio research at Northern Trust and an adjunct professor of economics at UCLA in Los Angeles, CA
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Abstract

Taxes introduce certain complexities, requiring proper adjustments to return and risk parameters. The author offers a refined set of after-tax return and risk equations for use in practice and validates them with a stochastic future value cash flow model. The refined after-tax return and risk parameters can be used in portfolio optimization, Monte Carlo simulation, and deterministic present/future value portfolio modeling with internally consistent results. The refinements improve the discovery of the optimal after-tax portfolio and enhance long-term wealth planning in the presence of risk.

TOPIC: Wealth management

Key Findings

  • • After-tax return and risk parameters are necessary for efficient asset allocation and accurate wealth planning.

  • • Parameters must incorporate tax complexity while producing internally consistent results across portfolio optimization, Monte Carlo simulation, and deterministic modeling.

  • • Refinements include the arithmetic-geometric return treatment with tax, a more precise incorporation of the effective annual capital gains tax rate, and risk manifesting in the price return across the distribution.

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The Journal of Wealth Management: 23 (2)
The Journal of Wealth Management
Vol. 23, Issue 2
Fall 2020
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Refining After-Tax Return and Risk Parameters
Peter Mladina
The Journal of Wealth Management Jul 2020, 23 (2) 8-17; DOI: 10.3905/jwm.2020.1.112

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Refining After-Tax Return and Risk Parameters
Peter Mladina
The Journal of Wealth Management Jul 2020, 23 (2) 8-17; DOI: 10.3905/jwm.2020.1.112
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  • Article
    • Abstract
    • THE STANDARD AFTER-TAX FRAMEWORK
    • INCOME RETURN AND PRICE RETURN
    • REFINING THE AFTER-TAX MEAN RETURN
    • REFINING AFTER-TAX RISK
    • VALIDATION
    • NON-TAX EXPENSES
    • CONCLUSION
    • ADDITIONAL READING
    • APPENDIX
    • ENDNOTES
    • REFERENCES
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