We’ve spent the better part of the last 10+ years talking about the serious headwinds that taxes have on investor returns. It’s one thing to conceptually understand why taxes can reduce investment returns, but it’s a completely different thing to actually see how big this impact can be.
Seeing is believing
When evaluating investment options, investors typically go right to the pre-tax returns, net expense ratios, fund size, active share, portfolio turnover and similar statistics.
But for taxable investors, they almost always omit the figures that have as big or bigger of an impact: the amount of return surrendered to taxes and the actual after-tax returns. The return lost to taxes is often a higher number than the stated expense ratio. It serves as an additional fund expense for the benefit of Uncle Sam.
A new tool for enhanced visibility
To help investors see this tax impact, we’re thrilled to introduce the Tax Impact Comparison Tool. Imagine being able to show investors the magnitude of this hidden expense ratio. We work with and educate many advisors on how to incorporate the magnitude of tax drag with both clients and prospects. Making the evaluation of tax-managed investing easier can help these discussions be more compelling.
Discovery and insights across investment products & categories
This new online tool is intended as a resource to help advisors and their clients make informed decisions about the tax-impact of different investment products.
By way of example, looking broadly at U.S. equity products (active, passive, ETFs), the average product surrendered 2% of its pre-tax return to taxes for the three years ending June 2020, according to Morningstar.* Being an average, there are some investment products that are materially higher and lower.
With the ability to compare thousands of mutual funds, ETFs and Morningstar categories, you can better determine the tax implications between products and categories.
How to use the Tax Impact Comparison Tool in 3 easy steps
Step 2: Select a Russell Investments’ fund
Step 3: Then add a mutual fund, ETF and/or Morningstar peer universe category to compare
Two presentation options are available
The tool enables you to easily select two different views so you can look at both return lost to taxes and tax-adjusted returns or pre-tax returns.
1. Tax-adjusted returns:
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Tax-cost ratio / return lost to taxes:
- This hard-to-find number from Morningstar shows how much return is lost to taxes or the hidden expense ratio. Like all expenses, lower is better.
- Note the % Rank in Category. How did the product compare to peers in reducing tax drag? Again, lower is better.
- Tax-adjusted return shows the pre-liquidation after-tax return for selected products. These returns are oftentimes difficult to find elsewhere. We’ve brought these front and center for your review and show returns after accounting for paying relevant federal taxes on any income (dividends, interest) and capital gain distributions during the period. The calculation follows SEC methodology.
- Also note the % Rank in Category. Many funds will move up (or down) in their universe when taxes are taken into consideration.
2. Pre-tax returns:
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Note: For illustrative purposes only. Performance information is historical and does not guarantee future results.
- Shows standardized pre-tax returns investors are accustomed to seeing.
- Note the % Rank in Category and compare to ranking in Tax-Adjusted Return section. Did the fund move up or down vs. peers? A tax-managed offering should improve.
Pursuing value with tax-managed investing
In our annual Value of an Advisor study, helping clients reduce the impact of taxes is one of the greater value-adds advisors bring to the client relationship. Why? Because when it comes to investing, it’s not what investors make, it’s what they get to keep. That’s why we’re providing a tool that allows you to make better, informed decisions as you compare products to demonstrate the value of tax-managed funds.
The bottom line
Bringing this tool to the marketplace is another milestone in our drive to be an industry leader in tax-managed investing. We started this journey back in 1985 with the launch of our first tax-exempt bond fund, and we’ve been helping investors grow after-tax wealth ever since. In the late 90s we added tax-managed U.S. equity funds, introduced our Tax-Managed Model Strategies in 2003, and have followed that with product innovation in the international, real asset and high-yield space.
Today it’s exciting to share our Tax Impact Comparison Tool to help advisors make informed decisions about the tax impact of investments. This tool should help advisors bring even more value to their practice while helping investors keep more of what they make.
Expense ratios are as of the most recent prospectus (3/1/2020) or supplemental prospectus (9/9/2020).
The Net Annual Operating Expense Ratio for the Tax-Managed U.S. Large Cap Fund may be less than the Total Operating Expense Ratio and represents the actual expenses expected to be borne by shareholders after the application of:
▪ For M Share Class, a contractual transfer agency fee or advisory fee waiver through February 28, 2021;
▪ For A, C, M, and S Share Classes, a contractual cap and reimbursement on expenses through February 28, 2021;
These contractual agreements may not be terminated during the relevant periods except at the Board of Trustee's discretion. Details of these agreements are in the current prospectus. Absent these reductions, the fund's return would have been lower.
Tax-adjusted returns is defined as after-tax returns that are calculated using the historical highest individual federal marginal income tax rates, as well as the 3.8% net investment income tax, and do not reflect the impact of state and local taxes. Returns shown are pre-liquidation returns. Actual after-tax returns depend on an investor’s tax situation and may differ from those shown. After-tax returns shown are not relevant to investors who hold their Fund shares through tax-deferred arrangements such as 401(k) plans or individual retirement accounts. Returns After Taxes on Distributions may be the same as Returns Before Taxes for the same period if there were no distributions for that period.
Tax-cost ratio is defined as Morningstar’s Tax Cost Ratio, which measures how much a fund's annualized return is reduced by the taxes investors pay on distributions. Investors then must pay taxes on distributions during the year they were received. Like an expense ratio, the tax cost ratio is a measure of how one factor can negatively impact performance. For example, if a fund had a 2% tax cost ratio for the three-year time period, it means that on average each year, investors in that fund lost 2% of their assets to taxes. If the fund had a three-year annualized pre-tax return of 10%, an investor in the fund took home about 8% on an after-tax basis. (Because the returns are compounded, the after-tax return is actually 7.8%.)
MORNINGSTAR CATEGORY DEFINITIONS:
Large-blend portfolios are fairly representative of the overall U.S. stock market in size, growth rates, and price. Stocks in the top 70% of the capitalization of the U.S. equity market are defined as large-cap. The blend style is assigned to portfolios where neither growth nor value characteristics predominate. These portfolios tend to invest across the spectrum of U.S. industries, and owing to their broad exposure, the portfolios' returns are often similar to those of the S&P 500 Index.
Total Return Percentile Rank, Morningstar Category: Percentile rank is a standardized way of ranking items within a peer group, in this case, funds with the same Morningstar category. The observation with the largest numerical value is ranked one; the observation with the smallest numerical value is ranked 100. The remaining observations are placed equal distance from one another on the rating scale. Note that lower percentile ranks are generally more favorable for returns (high returns), while higher percentile ranks are generally more favorable for risk measures (low risk).
*U.S. Equity: Morningstar U.S. Equity Universes average. Morningstar’s tax cost ratio assumes the highest possible applicable tax rates, including the 3.8% net investment income tax. Many investors are not subject to the highest rates. Note that tax drag calculations only apply to taxable accounts.
Methodology for Universe Construction:
- Average of Morningstar’s Tax Cost Ratio for universes as defined.
- Averages calculated on a given category. For example, average reflects the arithmetic average of the Morningstar Tax Cost Ratio for the universe/category as listed. Data includes all share classes
- Large Cap/Small Cap determination based upon Morningstar Category.
- If fund is indicated by Morningstar as passive or an ETF, the fund is considered to be passively managed. Otherwise, the fund is considered to be actively managed.
- Tax Drag: Morningstar calculated Tax Cost Ratio.
- Morningstar Categories included:
- U.S. Equity: US Fund Large Blend, US Fund Large Value, US Fund Large Growth, US Fund Mid-Cap Blend, US Fund Mid-Cap Value, US Fund Mid-Cap Growth
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