After-tax Benchmarks? Not!

Maybe it’s hard to believe, but there are no readily-available published investment benchmark indices calculated and presented on an “after-tax” basis. However, this should not be surprising given the personal and complex nature of taxes. For example, everyone has their own personal “effective” tax rate and also their own variable timing of cost basis and the receipt of taxable income; not to mention the realization of capital gains and losses; short- and long-term!!

I found an interesting article by Morgan Housel ( that got into some of the details on the impact of taxes on a taxable equity portfolio. He did the math and found that from 1993-2017 the S&P 500 returned 7.7%; add in dividends (that are taxable) and the pre-tax return jumps to 9.7%. Add in an adjustment for inflation and you get a “real” return of 7.4%. Now, finally, factor in some assumptions for taxes on the dividends and you see a drag of 0.6% per year making the total return 6.8% annual return over the horizon. This is a bit intuitive since the S&P 500 currently yields about 2% per year; a 15% Fed tax on qualified dividends plus an assumed 5% state tax (totaling 20%) puts the tax cost at about 0.4% per year (not including compounding, etc.). But, of course, not everyone is paying 15% Fed tax or 5% state tax, hence the benchmarking problem! And, most investors also have some non-qualified dividends and bond interest that are taxed as ordinary income, making the problem even more complex.

What do we do without an after-tax benchmark? There are few things, but one approach is to look at each distinct holding in a portfolio and evaluate its relative attractiveness on an after-tax basis. For example, compare tax-free municipal bond rates to taxable corporate bond rates on an after-tax basis. Today, the median A-rated tax-free municipal bond has a yield of 1.97% and the median A-rated corporate bond has a higher yield of 2.82%. Simple math shows that for any effective tax rates lower than 30%, it is more economic to buy the corporate bond (i.e., 0.70 * 2.82% = 1.97%) and vice versa. This analysis, however, ignores risk measures, portfolio correlations, and ignores the possibility of trading and perhaps generating gains or losses.