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Finance For Dummies

Finance For Dummies offers personal finance information on investing, retirement investing, finance, insurance, credit cards, loans and more. Personal finance education is our goal.

Friday, September 08, 2006

Returns before and after Taxes

Obviously, taxes reduce the amount of return you receive on your investments. Here we will examine a hypothetical investor that has a normal long-term investment strategy and the tax consequences involved.

Assume that stocks after taxes were purchased and held for five years and then sold then capital gains kicks in. The net proceeds from the sale were reinvested as were any dividends. From 1926-2000 the average return for this portfolio was 11%, but only 8.5% after taxes.

Now bonds were turned over 20 times within this same 75-year period. Capital gains were reinvested at sale. Bonds averaged 3.8% after taxes compared to 5.3% before. This 3.8% barely outpaced inflation. Holding cash will earn you 2.2% after and 3.8% before taxes--you actually lose money this way.

Therefore, it is essential to understand the tax-impact on your portfolio to know your true return.

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