Why understanding the real return after taxes, fees, and expenses is an important goal
Having a proper tax plan can make a huge impact on your take home return
During the process of cash flow planning with clients, there comes a time when we discuss the expected rate of growth for their investments. Oftentimes, we hear mainstream media quoting that the market's historical return over the last 30 years is between 10-12%. Many investors hear this and assume that these nominal returns on investments are a reasonable expectation for the future. But in reality, the real real return, is substantially less than that due to taxes, expenses, and inflation. Thornburg Funds wrote a great piece that discusses this topic in greater depth, A Study of Real Real Returns. (Also, see their chart below.)
Most investors realize that nominal returns include inflation, which must be subtracted in order to get the real return on their investments. The problem is after taking out inflation, many investors assume they get to keep the rest. Some investors do not realize how taxes can be a huge impact on their take home return when there is a lack of tax planning. According to a hypothetical model by Thornburg Funds, taxes reduce returns by 1.58%.
As wealth managers, we understand that the real return after taxes, fees, and expenses is always our goal. One of the reasons we focus so much on tax planning around employee benefits and qualified retirement plans (e.g., IRA, 401k, and 403b) is because we know tax mitigation has a huge impact on real returns. Having the precise assets in the correct allocation within the appropriate type of account is important in order to not leave money on the table.