Focus on Maximizing Wealth Rather Than Minimizing Taxes
Doug Walters
At tax season, it is a good time to remind investors that their goal should be maximizing after-tax returns not minimizing their tax bill. There’s a difference.
Contributed by Doug Walters , David Lemire , Max Berkovich , Eh Ka Paw
Stocks took a breather this week as investors tried to absorb the one-two punch of incrementally hawkish Federal Reserve rate commentary and a higher-than-expected inflation print. We discuss these more in our Headline of the Week below, and here, we focus on another topic that is top of mind for investors: taxes.
With the tax season upon us, it is an opportune time to revisit the intersection of taxes and investments. By a show of hands, who amongst our readers likes paying taxes? I suspect there are none out there. Of course not. Why would you want to hand over a portion of the fruits of your labor?
On the other hand, taxes are inevitable. And in theory, the more successful you are as an investor, the more taxes you will (or eventually will) have to pay. I’d personally rather be a wildly successful investor paying high taxes than a mediocre one with a low tax bill.
The right way to think about taxes (as evidence-based investors do) is to seek to maximize after-tax returns while maintaining an appropriate level of market risk. Yet, all too often, we see investors thinking about taxes first and returns and risks second. A couple of good examples are:
- Maintaining strict capital gains limits, resulting in a portfolio that becomes too risky over time because big market winners never get sold.
- Pursuing tax-advantaged securities like municipal bonds, even when there are better after-tax opportunities in taxable bonds.
Does that mean investors should ignore the impact of taxes? Absolutely not. Investors should use every tool at their disposal to minimize the tax burden on their investments. Such as:
- Utilizing tax-advantaged accounts (Roth IRAs, 401Ks, 529s, HSAs, etc.).
- Considering which types of assets to hold where (a.k.a. asset location).
- Harvesting tax losses (utilizing losses in your portfolio to offset gains).
- Utilizing exchange-traded funds (ETFs), which are generally more tax-efficient than mutual funds.
Smart tax management is not the same as tax minimization. If you’ve done what you can to defer or avoid excess capital gains taxes and maximize after-tax returns, take solace if your tax bill is high because the alternative (no gains) is far worse.
CPI Inflation in March
The Consumer Price Index (CPI), a common inflation measure, came in at 3.5% compared to the 3.4% expected by economists. The Fed still has work to do.
Headline of the Week
Three Strikes And Rate Cuts Are Out
This week’s inflation report once again came in higher than expected (for the third month in a row). The most recent polling at the Fed showed most favored three or two cuts this year. The “or two” was a new tweak, and this most recent inflation report has many on Wall Street editing it to “or zero.” The Fed Chair has remained consistent in preaching about data dependence. He also highlighted that the Fed did not overreact when inflation cooled significantly towards the end of last year and did not overreact to this year’s higher inflation reports. Whether the potential for higher inflation takes on greater significance to Fed deliberations will be an area of even more intense focus (as if that’s possible) ahead of each meeting from here on out.
The Week Ahead
No inflation reports, no jobs reports, and no Federal Reserve meeting next week should leave big bank earnings as the lone driver of market action unless geo-politics rears its ugly head.
All the Tea in China
The week will tee off with a rate decision from the People’s Bank of China (PBoC) and then Gross Domestic Product (GDP) for the first quarter on Tuesday.
- The PBoC passed on altering short rates last month and is expected to continue with that on the heels of a surprising rebound in manufacturing data.
- The GDP report is expected to miss targets, with the economy expanding by 4.6% year-over-year.
- 4.6% would be a rocky start for China, with a target of 5% for the year.
- House prices and retail sales numbers are also coming. If they surprise to the upside, investors may start looking for green shoots for the economy besieged by an ailing property market.
Going Shopping
The only consequential economic releases for us at home are the Retail Sales report and the Federal Reserve’s Beige Book.
- Headline Retail Sales numbers are expected to have a slight increase in March of 0.3%, which is a cooling from February.
- Economists are expecting a boost in spending from tax refunds, as early indications have tax refunds 5% higher than the previous year through March.
It’s That Time Again!
The first quarter earnings season officially started and hits hard next week.
- Major Banks dominate the first full week, with Goldman Sachs (GS), Bank of America (BAC), American Express (AXP), and Morgan Stanley (MS) standing out as the biggest.
- The other giants scheduled for next week are health insurer UnitedHealth (UNH), consumer giant Procter & Gamble (PG), and healthcare goliath Johnson & Johnson (JNJ).
Star Power
For some, Augusta, Georgia, is the place to be this weekend. For others, it’s Washington, DC, next week for the World Bank/International Monetary Fund (IMF) spring meeting.
- The IMF will release a global economic outlook, while G7 and G20 policymakers get together for a few days.
- A key topic is expected to be the elevated debt level in the emerging world.
- Judging from the field of players, the Masters will have just as much international flavor as the IMF meeting.
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