Taxable Investing > Details > Marginal After-Tax Returns

Marginal after-tax returns account for the management fees, income taxes and capital gains taxes under the assumption that market value equals cost basis.


rAT = (1 - tI )(rI - mf )+ (1 - TtG )rG 

rAT = marginal after-tax total return
tI = income tax rate
rI = before-tax income return
= management fee
T = turnover
tG = capital gains tax rate
rG = before-tax capital gains return


The before-tax capital gains return, rG represents the expected price appreciation based on the starting market value at the start of the current period.  The assumption that the cost basis equals the market value means that the turnover only converts unrealized gains and losses to realized gains and losses based on the expected price appreciation.  Furthermore, any reduction in market value at the start of the period for either investor expenditures or portfolio reweighting has no tax impact and therefore no impact on marginal after-tax returns.

Technically, this means that marginal after-tax returns are invariant to changes in portfolio weights.  This is an important feature discussed in Optimizing with Taxes in the Complexities Section.

The table to the right shows a simple example.  Due to the market value equals cost basis assumption the marginal after-tax return equals the actual after-tax return.

Before-Tax Income Return 2.5%
Management Fee 50 basis points
Income Tax Rate 35%
Before-Tax Capital Gain Return 5.0%
Turnover 50%
Capital Gains Tax Rate 35%
Starting Cost Basis $1,000,000
Starting Market Value $1,000,000
Ending Capital Appreciation $50,000
Ending Income $25,000
Management Fees ($5,000)
Income Taxes ($7,000)
Capital Gains Taxes ($8,750)
Ending Net $1,054,250
Marginal After-Tax Return 5.4%
Actual After-Tax Return 5.4%