Maximizing After-Tax Returns: Advanced Tax-Efficient Investment Techniques

Understanding Tax-Efficient Investing

Investing is not just about the returns you earn but also about the returns you keep after taxes. Tax-efficient investing represents a strategic approach that aims to minimize tax liabilities on investment income, thereby maximizing after-tax returns. This section delves into the concept of tax efficiency in investing, its significance, and the impact of taxes on investment returns.

What is Tax-Efficient Investing?

Tax-efficient investing involves choosing investment strategies and financial products that have favorable tax treatment. The goal is to retain as much of your investment returns as possible by reducing the tax impact on those returns. This approach requires an understanding of how different investments are taxed and the use of strategies to minimize these taxes legally.

The Impact of Taxes on Investment Returns

Investment returns can be affected by several types of taxes, including:

• Capital Gains Tax: Taxes on the profit from the sale of an asset held for more than a year are known as long-term capital gains and are taxed at a lower rate than short-term capital gains, which are applicable on assets held for less than a year.
• Dividend Tax: Taxes on the distribution of a company’s earnings to its shareholders. The rate depends on whether the dividends are qualified or non-qualified.
• Interest Income Tax: Taxes on interest earned from bonds, savings accounts, and other interest-bearing investments. This income is usually taxed at the investor’s ordinary income tax rate.

Understanding these tax implications is crucial for investors, as they can significantly reduce net investment returns. For instance, high turnover rates in actively managed funds can lead to higher capital gains taxes, thus affecting the fund’s overall performance.

Why Tax Efficiency Matters

For investors, especially those in higher tax brackets, the impact of taxes on investment returns can be substantial. Tax-efficient investing becomes particularly important in such scenarios to preserve wealth and enhance long-term financial planning. It’s not just about selecting the right investments but also about managing these investments in a way that considers the tax implications.

Incorporating tax efficiency into your investment strategy involves more than just seeking out tax-advantaged accounts or products; it’s about a comprehensive approach that considers the timing of buy and sell decisions, the selection of investment vehicles, and the placement of these investments in the most tax-advantaged accounts available.

In conclusion, tax-efficient investing is a cornerstone of savvy financial planning. By understanding how different investments are taxed and employing strategies to minimize these taxes, investors can significantly increase their after-tax returns. This approach requires careful planning and ongoing management but can lead to substantial benefits over the long term. Engaging with a financial advisor who understands the intricacies of tax-efficient investing can provide tailored advice and strategies suited to individual financial situations and goals.

The Foundation of Tax-Efficient Investing

Before delving into the more advanced strategies for maximizing after-tax returns, it’s crucial to understand and apply the foundational principles of tax-efficient investing. These principles lay the groundwork for any sophisticated tax minimization strategy and are essential for both novice and experienced investors alike.

Asset Location: The First Step in Tax Efficiency

The concept of asset location is straightforward yet powerful. It involves strategically placing investments in accounts based on their tax treatment to optimize for tax efficiency. Here’s how it works:

• Tax-Deferred Accounts: Accounts like Traditional IRAs or 401(k)s allow investments to grow tax-deferred, meaning you pay taxes only upon withdrawal. These accounts are ideal for investments that generate high levels of taxable income, such as bonds or high-yield stocks.
• Tax-Exempt Accounts: Roth IRAs and Roth 401(k)s offer tax-free growth and withdrawals, making them suitable for high-growth investments that can benefit from tax-free earnings over the long term.
• Taxable Accounts: These accounts don’t offer specific tax advantages for gains or income, making them best suited for holding tax-efficient investments like index funds, ETFs, or stocks you plan to hold long term.

Understanding and utilizing asset location can significantly enhance after-tax returns by minimizing the tax impact on investment income and gains.

Table 1: Comparison of Account Types for Tax-Efficient Investing

Tax-Loss Harvesting: Turning Losses into Opportunities

Tax-loss harvesting is a technique used to reduce taxes by selling investments that are at a loss and replacing them with similar investments to maintain the overall investment strategy. This allows investors to offset capital gains with losses, reducing the overall tax liability. Key points include:

• Offsetting Capital Gains: Realized losses can offset both short-term and long-term capital gains. In years with high capital gains, tax-loss harvesting can be particularly beneficial.
• Carrying Forward Unused Losses: If your capital losses exceed your capital gains, you can use the loss to offset up to $3,000 ($1,500 if married filing separately) of other income. Unused losses can be carried forward to future years indefinitely.

The Role of Index Funds and ETFs

Index funds and ETFs (Exchange-Traded Funds) are inherently tax-efficient for several reasons:

• Lower Turnover Rates: These funds typically have lower turnover rates compared to actively managed funds, resulting in fewer taxable events.
• Capital Gains Distributions: Actively managed funds often distribute capital gains that are taxable to the investor. Index funds and ETFs, by tracking an index, typically generate fewer capital gains distributions.
• ETF Structure: ETFs have a unique structure that allows investors to buy and sell shares without triggering capital gains taxes, making them even more tax-efficient than traditional index funds.

Incorporating these foundational strategies into your investment approach is essential for building a tax-efficient portfolio. By understanding and applying the principles of asset location, tax-loss harvesting, and the benefits of investing in index funds and ETFs, investors can create a solid foundation for minimizing taxes and maximizing after-tax returns. These strategies serve as the bedrock upon which more advanced tax-efficient investment techniques are built, paving the way for sophisticated investors to further optimize their portfolios for tax efficiency.

Advanced Techniques for Maximizing After-Tax Returns

After establishing a foundation in tax-efficient investing, seasoned investors can leverage more advanced techniques to further optimize their portfolios for after-tax returns. These strategies require a deeper understanding of tax regulations and often involve more complex financial planning and management.

1. Tax-Efficient Fund Selection

Choosing the right investment vehicles is crucial for tax-efficient investing. Beyond the basic choice between index funds and actively managed funds, investors should consider the following criteria when selecting tax-efficient funds:

• Turnover Rate: A fund’s turnover rate, or the frequency with which assets within the fund are bought and sold, can significantly impact its tax efficiency. Higher turnover rates can lead to higher capital gains distributions, which are taxable to the investor. Look for funds with low turnover rates to minimize these taxable events.
• Capital Gains Distributions: Some funds are managed in a way that minimizes capital gains distributions, which can be advantageous for investors in taxable accounts. Before investing, review a fund’s history of capital gains distributions to gauge its tax efficiency.
• Fund Structure: The structure of the fund itself can influence its tax efficiency. For example, ETFs often have a tax advantage over mutual funds due to their unique creation and redemption process, which typically results in fewer taxable events.

When selecting funds, it’s also important to consider the tax implications of any dividends. Funds that focus on qualified dividends can offer better tax treatment compared to those that generate non-qualified dividends.

Considerations for Tax-Efficient Fund Selection

• Review the Fund’s Prospectus: This document contains valuable information about the fund’s investment strategy, turnover rate, and past capital gains distributions.
• Assess the Fund’s Holdings: Understanding the types of securities a fund holds can provide insight into its potential tax efficiency. For example, funds that invest heavily in bonds may generate more taxable income than those focused on growth stocks.
• Check the Tax Cost Ratio: Some financial platforms provide a tax cost ratio for funds, which estimates the impact of taxes on the fund’s annual returns. A lower tax cost ratio indicates higher tax efficiency.

Selecting tax-efficient funds is a nuanced process that requires a careful examination of a fund’s characteristics and performance. By prioritizing funds with low turnover rates, minimal capital gains distributions, and structures conducive to tax efficiency, investors can significantly reduce the tax drag on their portfolios, thereby enhancing after-tax returns.

In the next sections, we’ll explore additional advanced strategies, including the use of tax-deferred accounts, strategic asset allocation and location, charitable giving strategies, direct indexing, and estate planning considerations, to further maximize tax efficiency and after-tax returns.

2. Utilizing Tax-Deferred Accounts

Tax-deferred accounts, such as Traditional IRAs, 401(k)s, and similar retirement accounts, offer unique opportunities for tax-efficient investing. Contributions to these accounts may reduce your taxable income in the contribution year, and investments within these accounts grow tax-deferred until withdrawals are made, typically in retirement.

Strategic Use of Tax-Deferred Accounts

• Defer Taxes on High-Income Investments: Place investments that generate regular income, such as bonds or dividend-yielding stocks, in tax-deferred accounts to avoid annual taxes on the income they produce.
• Consider Tax Diversification: Balancing investments between tax-deferred and Roth (after-tax) accounts can provide tax diversification, offering flexibility in managing taxable income during retirement.

Roth Conversions and the Backdoor Roth IRA Strategy

• Roth Conversions: Converting funds from a Traditional IRA to a Roth IRA can be a strategic move, especially in years when your income is lower. This involves paying taxes on the converted amount but allows for tax-free growth and withdrawals in the future.
• Backdoor Roth IRA: For high-income earners who exceed the income limits for direct Roth IRA contributions, the backdoor Roth IRA strategy involves making a non-deductible contribution to a Traditional IRA and then converting it to a Roth IRA. This strategy allows investors to benefit from Roth IRA’s tax-free growth, despite income limitations.

Considerations for Tax-Deferred Investing

• Understand the Tax Implications: Withdrawals from tax-deferred accounts are taxed as ordinary income, so it’s important to consider the potential tax rates during retirement.
• Required Minimum Distributions (RMDs): Tax-deferred retirement accounts are subject to RMDs, which require you to start taking withdrawals by a certain age. Planning for these distributions is essential to avoid unexpected tax bills.

Utilizing tax-deferred accounts effectively requires a strategic approach that considers your current tax situation, expected tax rates in retirement, and the specific tax characteristics of your investments. By carefully selecting which assets to place in these accounts, you can defer taxes on investment gains and income, potentially reducing your overall tax burden and enhancing your after-tax investment returns.

In the upcoming sections, we will explore additional advanced strategies, including strategic asset allocation and location, charitable giving strategies, direct indexing, and considerations for estate planning, to further refine your approach to tax-efficient investing and maximize your after-tax returns.

Table 4: Advanced Tax-Efficient Investment Techniques and Their Implications

3. Asset Allocation and Location

A nuanced approach to asset allocation and location can significantly enhance the tax efficiency of an investment portfolio. This strategy involves not only deciding how much to invest in various asset classes but also determining the most tax-efficient account type (taxable, tax-deferred, or tax-exempt) for each class of asset.

Strategic Asset Allocation

• Growth Investments: Equities and equity-focused funds, especially those expected to appreciate over the long term, are best held in taxable or Roth accounts where capital gains are taxed at lower rates or are tax-free, respectively.
• Income-Generating Investments: Bonds, REITs, and other investments that generate regular income are more tax-efficient in tax-deferred accounts where their income won’t be taxed until withdrawal.

Asset Location Considerations

• Taxable Accounts: Ideal for holding assets that are expected to benefit from long-term capital gains treatment, tax-efficient index funds, and ETFs, as well as investments that can take advantage of tax-loss harvesting.
• Tax-Deferred Accounts: Suitable for investments that generate high levels of ordinary income, such as bonds or CDs, to defer taxes on this income until withdrawal.
• Roth Accounts: Best for high-growth investments, as withdrawals are tax-free in retirement, maximizing the benefit of long-term growth.

Balancing Asset Allocation and Location

• Review Regularly: Asset allocation and location should be reviewed periodically to ensure alignment with overall investment goals, tax laws, and market conditions.
• Rebalancing: Strategic rebalancing within the appropriate accounts can help maintain the desired asset allocation without incurring unnecessary tax consequences.

Strategic asset allocation and location are about placing the right investment in the right type of account to optimize for tax efficiency. By understanding the tax implications of different investments and account types, investors can make informed decisions that align with their long-term financial goals while minimizing their tax liability.

In the following sections, we’ll delve into charitable giving strategies, direct indexing, and estate planning considerations as further means to enhance the tax efficiency of your investment portfolio and maximize after-tax returns.

Table 2: Strategies for Asset Allocation and Location

4. Charitable Giving Strategies

Charitable giving can be an effective way to manage your tax liability while supporting causes you care about. When incorporated into your investment strategy, charitable contributions can enhance tax efficiency and potentially increase the overall impact of your donations.

Donating Appreciated Securities

• Avoid Capital Gains Tax: Donating stocks or other securities that have appreciated in value directly to a charity can be more tax-efficient than selling the assets and donating the cash. This method allows you to avoid paying capital gains tax on the appreciation, and you may be eligible for a tax deduction based on the full market value of the donated securities.
• Maximize Donation Impact: By not incurring capital gains taxes, the full value of your investment goes to the charity, maximizing the impact of your donation.

Setting Up a Donor-Advised Fund (DAF)

• Immediate Tax Benefit: Contributions to a DAF are tax-deductible in the year they are made, even though distributions to charities can occur over time.
• Flexibility and Control: A DAF allows you to recommend grants to charities of your choice at a pace that suits you, while the funds potentially grow tax-free, increasing the available amount for future donations.
• Strategic Giving: A DAF can be a strategic part of your tax planning, allowing for larger upfront contributions in high-income years, which can be used to smooth out charitable giving over time.

Estate Planning and Charitable Bequests

• Reduced Estate Taxes: Including charitable gifts in your estate plan can reduce the size of your taxable estate, potentially lowering estate taxes.
• Legacy Giving: Leaving a charitable legacy can be a meaningful way to support causes important to you beyond your lifetime, while also providing tax benefits to your estate.

Considerations for Charitable Giving Strategies

• Understand the Limits: The IRS has limits on the deductibility of charitable contributions, based on a percentage of your adjusted gross income (AGI). It’s important to understand these limits and plan your donations accordingly.
• Documentation and Valuation: Keep thorough records of your charitable contributions, especially for non-cash donations like securities, where valuation at the time of donation is crucial for tax purposes.

Incorporating charitable giving into your investment strategy can provide significant tax advantages while allowing you to support the causes you value. By strategically choosing how and what to donate, you can optimize the tax benefits of your charitable contributions, enhancing your overall tax efficiency and potentially increasing the impact of your donations.

In the next sections, we will explore direct indexing and estate planning considerations as additional advanced techniques to further optimize your investment portfolio for tax efficiency.

Table 3: Charitable Giving Strategies and Tax Benefits

5. Direct Indexing

Direct indexing is an advanced investment strategy that involves directly purchasing the underlying securities of an index, rather than investing in a mutual fund or ETF that tracks the index. This approach offers several tax advantages and customization options for sophisticated investors.

Tax-Loss Harvesting Opportunities

• Individual Security Control: Direct indexing allows investors to sell specific securities within the index that are at a loss, to offset gains elsewhere, enhancing the tax-loss harvesting strategy beyond what is possible with index funds or ETFs.
• Continuous Tax Management: Unlike mutual funds or ETFs, where tax-loss harvesting can only be done at the fund level, direct indexing allows for ongoing tax management at the individual security level.

Customization and Exclusion

• Personalized Portfolios: Investors can tailor their portfolios to exclude specific industries or companies they prefer not to invest in, aligning their investments more closely with their personal values or investment criteria.
• Sector Tilting: Direct indexing also allows for “tilting” the portfolio towards sectors or themes the investor believes will outperform, providing a level of customization not available in traditional index investing.

Considerations for Direct Indexing

• Minimum Investment Requirements: Direct indexing often requires a significant minimum investment, making it more accessible to high-net-worth individuals or institutional investors.
• Complexity and Costs: Managing a portfolio that replicates an index can be more complex and potentially incur higher transaction costs compared to owning a single index fund or ETF.
• Tax Implications: While direct indexing can offer tax benefits, it’s essential to manage it carefully to avoid unintended tax consequences, particularly in accounts subject to wash-sale rules.

Direct indexing represents a sophisticated strategy that leverages the benefits of index investing while offering enhanced tax efficiency and customization. By allowing for individual security selection and tax-loss harvesting, direct indexing can significantly improve the after-tax performance of your investment portfolio. However, due to its complexity and the resources required to implement it effectively, it’s often best suited for investors with substantial assets and a strong understanding of tax implications and investment management.

In the next section, we will conclude our exploration of advanced tax-efficient investment techniques with a look at estate planning considerations, an essential aspect of comprehensive financial planning that can further enhance the tax efficiency of your investment strategy.

6. Estate Planning and Tax Efficiency

Estate planning is a crucial component of a comprehensive investment strategy, particularly for investors concerned with the tax efficiency of wealth transfer to their heirs. Advanced estate planning techniques can help minimize estate taxes and maximize the value passed on to the next generation.

Gifting Appreciated Assets

• Lifetime Gift Exemption: Utilize the lifetime gift tax exemption to transfer appreciable assets out of your estate. This can reduce the size of your taxable estate and allow the assets to appreciate in the hands of the recipient, potentially reducing overall estate tax liability.
• Annual Gift Tax Exclusion: Take advantage of the annual gift tax exclusion to transfer wealth to heirs without incurring gift tax or using the lifetime exemption.

Trusts for Tax Efficiency

• Irrevocable Trusts: An irrevocable trust can be used to remove assets from your estate, reducing estate taxes while providing controlled benefits to the trust beneficiaries.
• Charitable Remainder Trusts (CRTs): CRTs allow you to receive income or a tax deduction during your lifetime, with the remainder of the trust assets going to a designated charity, potentially reducing estate and income taxes.

Family Limited Partnerships (FLPs)

• Asset Control and Tax Benefits: FLPs can be used to transfer assets like a family business or real estate to family members at reduced tax rates, while still maintaining some level of control over the assets.

Leveraging Life Insurance

• Irrevocable Life Insurance Trusts (ILITs): An ILIT can own a life insurance policy on your life, removing the death benefit from your estate and providing tax-free funds to your beneficiaries, which can be used to pay estate taxes or for other purposes.

Considerations for Estate Planning

• Regular Review and Updates: Estate planning strategies should be reviewed regularly and updated as laws change and your personal and financial situations evolve.
• Professional Guidance: Due to the complexity and legal implications of many estate planning techniques, it’s crucial to work with experienced professionals, including estate planning attorneys and tax advisors.

Advanced estate planning techniques can significantly enhance the tax efficiency of your investment strategy, particularly in the context of wealth transfer and legacy planning. By carefully structuring how your assets are held, gifted, and bequeathed, you can reduce tax liabilities, protect your wealth, and ensure that your financial legacy is passed on according to your wishes.

This concludes our exploration of advanced techniques for maximizing after-tax returns through tax-efficient investment strategies. By integrating these strategies into your overall financial plan, you can optimize your investment portfolio for tax efficiency, ensuring that you maximize your after-tax wealth and achieve your long-term financial goals.

Frequently Asked Questions (FAQ) on Tax-Efficient Investing

What is tax-efficient investing?

Tax-efficient investing involves strategies and choices designed to minimize the tax burden on investment returns, thereby maximizing after-tax income. It includes selecting tax-friendly investments, utilizing tax-advantaged accounts, and employing techniques like tax-loss harvesting.

How does asset location affect tax efficiency?

Asset location is the practice of placing investments in the most tax-advantaged accounts available. For example, holding high-income investments like bonds in tax-deferred accounts can defer taxes on interest income, while placing capital growth investments like stocks in taxable accounts can take advantage of lower long-term capital gains tax rates.

What is tax-loss harvesting and how does it work?

Tax-loss harvesting is a strategy where investors sell securities at a loss to offset capital gains taxes. These losses can be used to offset current capital gains, and if losses exceed gains, up to $3,000 can be used to offset other types of income annually, with the remainder carried forward to future years.

Can Roth conversions improve tax efficiency?

Yes, Roth conversions can enhance tax efficiency by converting funds from tax-deferred accounts (like Traditional IRAs) into Roth IRAs, where future withdrawals are tax-free. This can be especially beneficial in years of lower income, although it requires paying taxes on the converted amount at the time of conversion.

What is direct indexing, and how does it benefit tax efficiency?

Direct indexing involves buying the individual stocks of an index, allowing investors to own the underlying assets directly. This approach offers greater control over the portfolio, facilitating personalized tax-loss harvesting and portfolio customization, potentially leading to greater tax efficiency compared to traditional index funds.

How do charitable giving strategies provide tax benefits?

Charitable giving, such as donating appreciated securities or using a Donor-Advised Fund (DAF), can offer significant tax advantages. Donating appreciated securities directly to a charity avoids capital gains taxes, while contributions to a DAF provide an immediate tax deduction and allow for the strategic timing of donations.

What are some estate planning techniques for tax efficiency?

Estate planning techniques like gifting, trusts, and family limited partnerships can help reduce estate taxes and efficiently transfer wealth. Strategies like using an Irrevocable Life Insurance Trust (ILIT) can remove life insurance proceeds from the taxable estate, providing tax-free benefits to heirs.

Are there any risks associated with advanced tax-efficient strategies?

Advanced strategies often involve more complexity and require careful planning to avoid unintended tax consequences. It’s important to consider factors like future tax rates, investment minimums, and the potential for legislative changes. Consulting with a tax advisor or financial planner is recommended to navigate these complexities effectively.

Example Tax-Efficient Investing Checklist

Understand the Basics

• Familiarize yourself with tax-efficient investing concepts.
• Learn about the tax treatment of different investment types (stocks, bonds, mutual funds, ETFs).

Assess Your Current Portfolio

• Review your investment portfolio for tax efficiency.
• Identify assets that could benefit from being placed in different account types (taxable, tax-deferred, tax-exempt).

Utilize Tax-Advantaged Accounts

• Maximize contributions to tax-advantaged accounts like IRAs, 401(k)s, and Roth accounts.
• Consider the benefits of Roth conversions in years of lower income.

Implement Asset Location Strategies

• Allocate high-growth investments to Roth or taxable accounts for long-term capital gains tax benefits.
• Place income-generating investments in tax-deferred accounts to defer taxes on interest and dividends.

Engage in Tax-Loss Harvesting

• Monitor your portfolio for opportunities to realize losses to offset gains.
• Understand the wash-sale rule to avoid disallowed tax deductions.

Select Tax-Efficient Investment Vehicles

• Choose index funds and ETFs for lower turnover and fewer capital gains distributions.
• Consider direct indexing for greater control and personalized tax-loss harvesting opportunities.

Plan for Charitable Giving

• Identify appreciated assets for charitable donations to avoid capital gains taxes.
• Explore setting up a Donor-Advised Fund (DAF) for more strategic charitable giving.

Incorporate Estate Planning Techniques

• Consult with an estate planning advisor to discuss strategies for tax-efficient wealth transfer.
• Consider establishing trusts, gifting strategies, or family limited partnerships as part of your estate plan.

Regular Review and Rebalancing

• Schedule regular portfolio reviews to adjust for tax efficiency and investment goals.
• Rebalance your portfolio within tax-advantaged accounts to minimize tax consequences.

Consult with Professionals

• Seek advice from tax professionals or financial advisors to navigate complex tax situations.
• Regularly update your tax planning strategies based on changes in tax laws and personal circumstances.

Glossary of Tax-Efficient Investing Terms

Asset Location

The strategic placement of investments across different types of accounts (taxable, tax-deferred, tax-exempt) to optimize for tax efficiency based on the tax treatment of investment returns.

Capital Gains Tax

Taxes owed on the profit made from selling an asset that has increased in value. Long-term capital gains tax applies to assets held for more than one year and is typically lower than short-term capital gains tax, which applies to assets held for less than a year.

Direct Indexing

A strategy that involves purchasing the individual securities that comprise a market index instead of investing in a mutual fund or ETF that tracks the index. This allows for greater customization and tax management opportunities, such as tax-loss harvesting at the individual security level.

Donor-Advised Fund (DAF)

An investment account dedicated to charitable giving that allows donors to make a charitable contribution, receive an immediate tax deduction, and then recommend grants from the fund over time.

Estate Planning

The process of organizing one’s financial affairs to ensure efficient wealth transfer to heirs or beneficiaries, often involving strategies to minimize estate taxes and ensure the desired distribution of assets.

Exchange-Traded Fund (ETF)

An investment fund traded on stock exchanges, much like stocks, that holds assets such as stocks, commodities, or bonds. ETFs typically offer tax efficiency and lower operating costs.

Index Fund

A type of mutual fund or ETF designed to follow the components of a market index, such as the S&P 500. Index funds are known for their tax efficiency due to low turnover rates.

Roth Conversion

The process of converting funds from a tax-deferred account, like a Traditional IRA, into a Roth IRA, where future withdrawals are tax-free. This conversion is taxable in the year it occurs.

Tax-Deferred Account

An investment account like a Traditional IRA or 401(k) where contributions may reduce taxable income in the year they are made, and taxes on investment gains are deferred until funds are withdrawn.

Tax-Exempt Account (Roth)

An investment account such as a Roth IRA or Roth 401(k) where contributions are made with after-tax dollars, but earnings and withdrawals are tax-free, subject to certain conditions.

Tax-Loss Harvesting

A strategy that involves selling securities at a loss to offset capital gains taxes on other investments. This can lower the investor’s tax liability and reposition the portfolio without altering its overall risk and return characteristics.

Turnover Rate

A measure of how frequently assets within a fund are bought and sold by the managers. High turnover rates can lead to higher capital gains distributions, which are taxable to the investors.