After-Tax After-Cost Returns

Your pre-tax return is fiction. The only return that matters is the one in your pocket: after taxes and costs.

Key takeaways

• A 7% pre-tax return becomes 5.5% after 2% in fees and taxes, or 4% after 4% in costs and taxes.
• Taxes are highest in taxable accounts (25–50% of gains depending on your bracket and state).
• Costs include fund expense ratios (0.03%–1%+), trading commissions, bid-ask spreads, and advisory fees.
• Tax-loss harvesting, holding periods (long-term vs short-term capital gains), and fund placement (tax-efficient funds in taxable accounts) all reduce your tax bill.
• Comparing pre-tax performance to a pre-tax benchmark is meaningless. Compare after-tax to pre-tax (the benchmark does not pay taxes).

Why pre-tax returns lie

Imagine two investors, both with portfolios that returned 7% last year.

Investor A holds their portfolio in a Roth IRA. No taxes are owed. The 7% is the real return.

Investor B holds their portfolio in a taxable brokerage account, in a high-income state (California), with a long-term capital gains rate of 20% (federal) + 13% (state) = 33% (hypothetical but illustrative).

Investor B's 7% pre-tax return becomes 7% × (1 - 0.33) = 4.7% after-tax return.

Both earned 7%, but only Investor A gets to keep 7%. Investor B keeps 4.7%, because 33% of the gain goes to taxes.

This is why comparing investments based on pre-tax returns is misleading. You do not spend pre-tax returns; you spend after-tax returns.

The components of after-tax return

After-tax return is the return after deducting:

1. Expense ratios (the cost of the fund itself).
2. Trading costs (bid-ask spreads, commissions if any).
3. Advisory fees (if you use a financial advisor).
4. Taxes (capital gains tax, dividend tax, interest tax).

A typical calculation:

After-tax return = Gross return - Expense ratio - Trading costs - Advisory fee - Taxes

Example:

• Gross return (what the market returned): 7%
• Expense ratio (cost of owning a VTI ETF): -0.03%
• Trading costs (bid-ask spread when you bought or rebalanced): -0.05%
• Advisory fee (0%, because you do not have an advisor): 0%
• Taxes (capital gains in a taxable account): -1.5% (assuming you harvest losses and hold mostly appreciated positions)
• After-tax return: 7% - 0.03% - 0.05% - 1.5% = 5.42%

This is what you actually earned.

Expense ratios: the most visible cost

Expense ratios are the easiest cost to measure because fund companies publish them. An expense ratio is the annual percentage of your assets the fund takes to pay for management, trading, and administration.

Examples (as of 2024):

• VTI (Vanguard Total Stock Market ETF): 0.03% per year
• SPY (SPDR S&P 500 ETF): 0.09% per year
• SCHX (Schwab US Large-Cap ETF): 0.04% per year
• Vanguard Total Bond Market (BND): 0.03% per year
• An active equity fund: 0.50–1.50% per year

Over 30 years, a 0.03% expense ratio costs much less than a 0.50% ratio. The difference compounds.

Example:

• $100,000 invested for 30 years at 7% gross return.
• With 0.03% fee: You end with $876,000 after fees, or $750,000 after a 33% tax hit.
• With 0.50% fee: You end with $758,000 after fees, or $648,000 after tax.
• The difference in after-tax wealth: $102,000.

For this reason, minimizing expense ratios is one of the highest-leverage decisions an investor can make. Choosing index funds (0.03–0.10%) over actively managed funds (0.50–2%+) can be worth $100,000+ over a lifetime.

Trading costs: bid-ask spreads and market impact

Every time you buy or sell a security, you pay a bid-ask spread: the difference between the price you pay to buy and the price you receive when you sell.

For a liquid ETF like VTI, the bid-ask spread is tiny (often under 0.01%). For an obscure stock, the spread might be 1% or more. This is a one-time cost when you buy, and another when you sell.

Example:

• You buy $10,000 of VTI. Bid-ask spread is 0.02%. Cost: $2.
• 30 years later, you sell. Spread is 0.02%. Cost: ~$30 (on a much larger position).
• Total trading cost: $32, or about 0.003% annualized over 30 years.

For a large portfolio or an active trader, bid-ask spreads and commissions add up quickly. For a passive investor who rebalances once per year, they are negligible.

Advisory fees: the big silent cost

If you work with a financial advisor (a robo-advisor or human), they typically charge either a percentage of assets under management (AUM) or an hourly/flat fee.

Common advisory fee structures:

• 1% AUM: You pay 1% of your assets every year. On a $500,000 portfolio, that is $5,000 per year.
• 0.50% AUM: $2,500 per year on the same portfolio.
• Flat fee: $2,000–$10,000 per year, regardless of assets.
• Hourly: $150–$400 per hour for planning or ongoing advice.

Advisory fees are not evil—advice can be valuable—but they must be weighed against the value received. A 1% annual fee over 30 years costs you about 25–30% of your potential wealth (compared to managing yourself or using a low-cost robo-advisor).

For most investors with simple portfolios, a robo-advisor at 0.20–0.50% AUM (or no fee at all) is a better choice than a 1% human advisor.

Taxes: the largest hidden cost

Taxes are the biggest after-cost for most investors in taxable (non-retirement) accounts.

Capital gains tax: When you sell an investment at a profit, the federal government taxes the gain. The rate depends on your holding period:

• Short-term capital gains (held less than 1 year): Taxed as ordinary income. For a high-income earner, this can be 37% federally (or higher including state/local taxes).
• Long-term capital gains (held 1+ year): Taxed at preferential rates: 0%, 15%, or 20% federal, depending on income, plus state/local taxes.

Dividend and interest tax: When a fund pays a dividend or bond pays interest, you owe tax on that income in the year received (even if you reinvest it). Qualified dividends are taxed at long-term capital gains rates (0–20%); ordinary dividends and interest are taxed as ordinary income (up to 37%).

Interaction with contributions: If you are a high earner making regular contributions, you will likely sell some appreciated positions to rebalance. Those sales trigger capital gains tax. If you harvest losses (selling losers to offset gains), you reduce the tax.

Strategies to reduce taxes

Tax-loss harvesting: Sell losing positions to offset gains. Example: You have VTI up $5,000 and BND down $2,000. Sell the BND loss, deduct it against the VTI gain, and eliminate $2,000 of taxable gain. Then buy BND back (or a similar bond fund) to stay invested.

Asset location: Put tax-efficient funds in taxable accounts and tax-inefficient funds in retirement accounts.

• Taxable account: VTI (index funds, low turnover, few distributions)
• Roth IRA: REIT or high-turnover funds (no tax impact inside the Roth)

Long-term holding: Sell only positions you have held for 1+ year (long-term capital gains rate, ~20% federal) rather than less than 1 year (37% federal).

Avoiding turnover: Rebalance only annually or when allocations drift significantly, not monthly or quarterly. Less rebalancing means fewer taxable sales.

Location arbitrage: In states with high income tax, consider putting bonds and dividend-paying stocks in tax-advantaged accounts, keeping them out of high-tax-state accounts.

Charitable giving: Donate appreciated securities directly to charity instead of selling them. You avoid the capital gains tax and get the full fair-market-value deduction.

Calculating your actual after-tax return

In your tracking spreadsheet, include a section for after-tax return. Here is the structure:

• Pre-tax return: Calculate using the formula from earlier articles (ending value minus beginning value minus contributions, divided by beginning value).
• Taxes owed: Sum the capital gains from sales and any dividends received. Multiply by your effective tax rate. (This is an approximation; for exact taxes, you need your tax return.)
• After-tax return: Pre-tax return minus (taxes owed / beginning value).

Example:

• Pre-tax return: 6%
• Beginning value: $100,000
• Taxes owed: $1,200 (from realizing gains and earning dividends)
• After-tax return: 6% - ($1,200 / $100,000) = 6% - 1.2% = 4.8%

You beat a 4% after-tax benchmark (which is realistic for a conservative allocation including bonds).

The after-tax benchmark problem

Here is a subtle but important issue: your benchmark (the S&P 500, Total Stock Market, etc.) is published as a pre-tax return. The market returns 7%, but as an investor in a taxable account, your after-tax version of that 7% return is only 5% or 4% (depending on your tax bracket).

So when comparing your performance, compare:

• Your after-tax return to the benchmark's pre-tax return.

If you earned 4.8% after-tax and the benchmark was 7% pre-tax, you did not underperform. You beat the benchmark by the amount of taxes, which is the best you can do (no investor owes less tax than you do by simply passively holding the benchmark).

Some sophisticated investors calculate an after-tax benchmark by estimating taxes on the benchmark (typically 1–2% per year) and comparing after-tax to after-tax. This is more accurate but requires more work.

Decision tree

Next

You now understand the returns that actually matter: after-tax, after-cost returns on a portfolio that has been designed to minimize both. But even the best portfolio needs regular checking. How often should you look, and how much should you move? The next article covers the monthly check-in ritual.

Related concepts

• Benchmarking Against an Index
• Time-Weighted vs Money-Weighted Returns
• Spreadsheet Tracking Basics