Effective Tax Rates

Using tax rates on asset classes in the Windham Portfolio Advisor

The Windham Portfolio Advisor provides a module to help estimate effective tax rates across asset classes. The program allows the analyst to include their own proprietary estimates of effective tax rates.
Two Methods of Tax Rate Inputs
Taxable investors should use after-tax returns and risks as inputs to a Markowitz portfolio construction analysis [Wilcox et. al. 2006]. Tax-advantaged accounts, such as pension plans and other retirement accounts, may be treated as different asset classes.
Effective Tax Rate Worksheet
Effective Tax Rate Worksheet
τn=(On×Φn)+(On×ψn)+(Q×δn)+(γ×υn)\tau_n=(O_n \times \Phi_n)+(O_n \times \psi_n)+(Q \times \delta_n) + (\gamma \times \upsilon_n)τn​=(On​×Φn​)+(On​×ψn​)+(Q×δn​)+(γ×υn​)
The worksheet in the Windham Portfolio Advisor calculates the effective tax ratesτn\tau_nτn​
 for each asset nnn
, as a function of ordinary income OOO
, federal tax rates Φ\PhiΦ
, state tax rates ψ\psiψ
, qualified dividends tax rates QQQ
,  qualified dividends δ\deltaδ
, the long-term capital gains tax rate γ\gammaγ
, and unrealized capital gains υ\upsilonυ
.
Estimated Effective Tax Rates
The estimated effective tax rates selection allow the analyst to specify proprietary estimates of effective tax rates across asset classes by editing the grid column, or by importing a vector of numbers from the clipboard / Excel.
Specify your own tax rates
How Are Tax Rates Applied?
The effective tax rates are applied to expected risk and return estimates across asset classes as specified by the user. To use after-tax estimates, check the After-Tax Estimates in the global ribbon bar.
Applying tax estimates to asset classes
Effective tax rates specified on the Define Taxes screen are applied to the expected returns E[R]E[R]E[R]
 and risk E[σ]E[\sigma]E[σ]
 of each asset class by discounting its pre-tax estimates:
E[R^]n=(1−τn)E[R]nE[\hat{R}]_n=(1-\tau_n) E[R]_n
E[R^]n​=(1−τn​)E[R]n​
E[σ^]n=(1−τn)E[σ]nE[\hat{\sigma}]_n=(1-\tau_n) E[\sigma]_nE[σ^]n​=(1−τn​)E[σ]n​
Subsequently, the after-tax estimates of expected return and risk for each asset class are used for portfolio construction, summarizing portfolio statistics, estimating exposure to loss, and as simulation inputs for risk management and cash flow analysis.
For a practical application on taxes in asset allocation, please see
Asset Allocation in Taxable Portfolios
Windham Insights
Application of Effective Tax Rates in Asset Allocation
​
References
Wilcox, J., Horvitz, J., and diBartolomeo, D. (2006). Investment Management for Taxable Private Investors. The Research Foundation of CFA Institute.

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