Tax-Aware Investing

Abstract

This study has three major sections. The first section examines how management style affects the share of returns received by and risk borne by the investor when stocks are held in a taxable account. One good management strategy is to manage stocks passively, ideally until the capital gains qualify for a step-up in basis at death or are used to fund a charitable contribution. The second examines the optimal location of assets in a portfolio comprising both taxable and tax-exempt pockets. It concludes that, to the degree possible without violating the target asset allocation, stocks should be passively held in taxable accounts and bonds should be held in retirement accounts. The third section examines dynamic tax-aware investing. Predictably, a good approximation to optimal behavior for a tax-aware investor is to realize all losses and let capital gains grow unrealized.