Explain how taxes shape both the choice of asset allocation and the approach to rebalancing

Taxable investors should optimise on after-tax returns and risk. After-tax expected return ≈ pre-tax return × (1 − t), so an 8% pre-tax return taxed at 35% becomes 5.2%; taxes on returns also reduce volatility, and different assets suffer different effective rates because income, dividends and capital gains are taxed differently. Asset location matters: place tax-inefficient assets such as taxable bonds in tax-deferred accounts, and tax-efficient assets in taxable accounts. Because rebalancing crystallises gains, corridors are widened: an after-tax band equals the pre-tax band ÷ (1 − t), so ±5% becomes about ±7.1% at a 30% rate. Tax-loss harvesting can offset gains. The trap is comparing pre-tax and after-tax allocations as if they were the same.