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What I Care About This Week | 2022 Feb 07

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by Franklin J. Parker, CFA

The Summary

The Details

One of the first papers that was published on goals-based investing (though it wasn’t called that at the time) was on the effects of taxes in a portfolio.* The authors demonstrated that active trading strategies, even if they deliver better risk-adjusted returns, are often not good enough to overcome the tax drag they can create. In other words, it may look good on a statement, but not so good when the tax man cometh.

Seems strange to say now, but that one should account for taxes in an investment strategy was a new concept in 1993! In any event, it is just as relevant today as then, and our current market environment is a reminder of this.

I have, for months, talked about the likelihood of a selloff in the face of changing Federal Reserve priorities. Exactly how portfolios were prepared for this selloff, however, had as much to do with each client’s tax situation and financial goals as it did my view of the selloff itself. For short-lived selloffs, it is often not profitable to sell highly-appreciated positions to reset at slightly lower prices. The taxes on those sales often erodes the benefits of active management, no matter how accurate that active management may be.

There are moments, of course, when it is worth the tax cost.

The point is simply this: taxes are a critical factor in your investment strategy. They must be accounted for. Taxes are also highly individualized, so it can easy to disregard these variables in a general strategy. That is, in my view, a mistake. Keep an eye on tax costs.

*Jeffrey, R., and R.D. Arnott (1993) “Is Your Alpha Big Enough to Cover Its Taxes?” Journal of Portfolio Management, DOI:

Chart of the Week

This week we check-in on corporate earnings. As a whole, the S&P 500 has had 77% of reported companies beat expectations, with an average surprise of 4%. Of the companies that have reported, tech has had the most companies beat expectations (communications have only had 5 earnings reports, so I discount their 100% above expectations figure).

In sum, this is turning out to be a pretty good earnings quarter for US companies. Outlooks have shifted, however, with some sectors seeing considerably more downward revisions than upward (materials, for example). Even still, as a whole, the S&P 500 is seeing more upward revisions in expected earnings than downward.

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