Tax drag
How far taxes reduce a portfolio's growth compared with what it would have earned untaxed. Tax paid every year compounds the loss, so deferring the same tax can leave noticeably more.
Where you will meet it
Tax drag appears in 3 learning outcomes on the CFA syllabus. A few of them:
- Assess how tax principles and tax costs affect goal-based and whole-of-family financial plans for individuals
“Assessing a plan means checking the tax drag on each sub-portfolio, the timing of realisations, the use of tax-advantaged accounts and residence-driven differences.”
- Contrast how bond portfolios are run for investors who pay tax and for those who do not
“The trap is recommending a high-turnover active strategy to a taxable client without counting the tax drag.”
- Explain how tax-efficient different asset classes tend to be and propose tax-management techniques for allocating assets
“Where regular income is taxed more heavily than deferred gains, bonds and high-yield income assets are less efficient, while low-turnover equity funds that defer gains are more efficient; high-turnover active strategies realise gains often and create tax drag.”
Practise it
Practise tax drag until it is automatic: questions that explain every wrong option.
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