After-tax return

Before you rely on it

What to check

Ask which account holds it first. The same fund taxed annually in a brokerage account and sheltered in an IRA gives two different answers.

The common error

Where people go wrong with after-tax return

Comparing a taxable holding to a sheltered one on gross figures. The comparison is not wrong at the edges, it is wrong at the core, because the two numbers are measuring different things.

Worked through

After-tax return in plain numbers

Two funds each earn 8% before tax on $10,000. Fund A pays its entire gain out as short-term distributions, taxed at 30%; the investor keeps $800 minus $240, which is $560. Fund B pays nothing out, and its investor sells at the end. Long-term gains are taxed at 15%, so the tax is $120 and $680 remains. Same 8% headline. After tax, one investor earned 5.6% and the other 6.8%. Stretch it over ten years with reinvestment and the gap widens, because Fund B's untaxed gains keep compounding while Fund A's investor pays each year and reinvests the smaller amount.

Easily confused

After-tax return and its neighbours

After-tax return is easy to confuse with the net return and the real return. Net return removes fees. Real return removes inflation. After-tax return removes taxes. One investment can be described by all three at once, and they subtract different things, and a 7% gross return with 1% in fees, tax at 15% on the gain and 3% inflation has four numbers attached to it, and quoting only one hides the rest. When a source says return, ask which of the adjustments it has already made; the answer changes what you can compare it against, and usually changes the ranking.

In real decisions

Where after-tax return turns up

It matters most when choosing where to hold an investment; a bond fund paying taxable interest can beat a stock fund inside an IRA and lose to it in a taxable account. Tax-exempt bonds look weak on gross yield and strong after tax; anyone comparing an employer plan with a brokerage account is really comparing two rule sets. Advisors use the idea to decide which assets go into which accounts, a practice often called asset location. It also explains why two people holding the same fund report different results for the same year, with no mistake on either side.

Know the edges

Where after-tax return stops being reliable

The figure leans on a tax rate that depends on your other income, and that rate can change during the holding period. Long-term and short-term gains are taxed differently, and state taxes add another layer. Estimates also assume you sell at the end. If you never sell, or leave the asset to heirs, tax may never be paid in the same way; a calculator can show the mechanics with the rates you type in. Your own situation needs your own tax facts, checked against current rules.