The Hidden Costs of Investing: The Tax Iceberg

Executive summary:

  • Most investors are aware of certain taxes on their investments, such as on dividends, interest and capital gains. But those are just the tip of the iceberg.
  • Activities related to investment strategies, such as changes in asset allocation, also trigger taxes
  • We provide some strategies that can help mitigate the impact of those “hidden taxes.”

We all know what sank the Titanic, right? Aside from the design failures and human error, it was the famous iceberg that sent the “unsinkable” ship to the bottom of the sea. The problem with icebergs is that what you see is not what you get! Most of the iceberg’s mass is hidden under the surface and that’s where the real danger lay for the Titanic.

At Russell Investments, we believe that one potential iceberg lurking under many investors’ portfolios is taxes.

When you invest in the stock market, you probably expect to earn returns based on the performance of your chosen securities. However, you may not realize that there is another factor that can affect your investment returns: taxes.

As investors we tend to only focus on a small part of the potential tax implications from investing– those which appear above the water, such as the taxes owed on dividends, interest and capital gains. However, these are, if you will pardon the pun, just the tip of the iceberg.

A portfolio may have other sources of taxation that are not so obvious and yet still create tax consequences. I often think of these hidden tax costs as the part of the tax iceberg hiding beneath the surface. These include:

  • Asset allocation changes
  • Fund or manager changes within a portfolio lineup
  • Portfolio rebalancing