Question

In: Accounting

Comment on the difference in turnover and the impact this would have on pre-tax and after-tax...

Comment on the difference in turnover and the impact this would have on pre-tax and after-tax returns. Which investment is likely to have the greater tax penalty? Why?

Vanguard Total Stock Market ETF (VTI) Turnover Rate - 4.10%

Fidelity's Magellan Fund (FMAGX) Turnover Rate - 106.00%

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Expert Solution

Pre-tax and after-tax returns

PRE TAX RETURNES

The pretax rate of return is the return on an investment that does not include the taxes the investor must pay on this return. Because individuals' tax situations differ and different investments attract varying levels of taxation, the pretax rate of return is the measure most commonly cited for investments in the financial world.

1. The pretax rate of return does not take into account capital gains or dividend taxes like the after-tax rate of return.

2. This is usually equal to the nominal rate of return and is the return most often quoted or cited for investments.

3. It enables comparisons to be made across different asset classes since different investors may be subject to different levels of taxation

          The pretax rate of return is the gain or loss on for an investment before taxes are taken into account. The government applies investment taxes on additional income earned from holding or selling investments.

AFTER TAX RETURNES

                     An after-tax return is any profit made on an investment after subtracting the amount due for taxes. Many businesses and high-income investors will use the after-tax return to determine their earnings.

1. An after-tax return is the profit realized on an investment after deducting taxes due.

2. After-tax returns help investors determine their true earnings.

3. After-tax ratios can be expressed as the difference between the market's beginning and ending values or as a ratio of after-tax tax returns to beginning market value.

4. When calculating the after-tax return, it is important to only include income received and costs paid during the reporting period

        After-tax returns break down performance data into "real-life" form for individual investors. Businesses and high tax bracket investors use after-tax returns to determine their profits. An after-tax return can be expressed nominally as the difference between an investment’s beginning market value and ending market value plus any dividends, interest, or other income received and minus any costs or taxes paid. After-tax can be represented as the ratio of after-tax return to beginning market value, which measures the value of the investment’s after-tax profit, relative to its cost.

After-tax option may be right for you if:

a. You expect your taxes to be higher in retirement. You may save by paying a lower tax rate on your savings today.

b. You have many years to build your savings. You’ll pay income taxes on what you contribute today, but you may not pay income taxes on the earnings*, which can add up over your working years.

c. You’re well-prepared for the future and would like to have both pretax and Roth after-tax savings to draw from in retirement.

The pretax option may be right for you if:

a. You expect your income taxes to be lower in retirement. You may save by lowering your taxable income now and waiting to pay taxes on your savings until after you retire.

b. You aren’t well-prepared for retirement. Saving on a pretax basis allows you to save in your plan while enjoying current tax savings.

  

The Fidelity’s Magellan Fund has a higher turnover rate which indicates that it replaces most or all of its holdings over a one-year period. The higher the turnover signifies that the investment is actively managed. The ETF’s are more tax efficient because they generally

Create fewer taxable events. A significantly lower portfolio turnover rate means significantly fewer taxable gain incidents. Compare the short- and long-term performance history of the two funds. Mutual fund performance is reported NET of the expense ratio (e.g. after fees). Do fees explain the performance difference over the short and long-term .Fidelity Magellan Fund has a better return short-term? Long-term performance is better for the Vanguard Total Stock. Fees explain the performance difference because Vanguard has lower fees for long-term investment. The more investors pay in fees and expenses, the less money they will ultimately have in their investment portfolio


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