Dear Clients & Friends, This weekend’s reading may, on the surface, seem boring, but I promise you that it’s really not. In fact, this reading will probably help everyone, and I really mean everyone, understand how to look at portfolio performance just a little bit better. This will be the first of two weekend readings about performance, so here goes; indulge me while I geek it out! Common sense would dictate that performance is very straightforward and easy to understand- if you have $20 and you make $1 from that, you’ve made 5%. Bang, easy. But in the modern world of complex financial instruments and information overload, it’s easy to misunderstand what you’re looking at. Thus, I wanted to write briefly about the difference between “principal gain and loss” and “tax gain and loss,” and show you how to find each of them when you are viewing your accounts via Investor 360, our website. Principal gain and loss is likely what you think it is- the amount of money that you have made “all-in” from a particular investment, regardless of where that profit came from. Imagine that you have invested $100, and this investment grows in value by $6. You’ve also re-invested $2 in interest; thus, the value of the investment is $108, and you’ve earned 8%. Now let’s consider a second example. If this original investment of $100 declined in value by $2, but you’ve reinvested $9 in interest, then the new “net” value would be $107, and you’ve earned 7%. Tax gain and loss can be explained by considering the second example from above. An investment of $100 declined in value by $2, but you’ve reinvested $9 in interest while you’ve held it. While you’ve earned a net return of 7%, if you then sold the investment, you would show the IRS a loss of $2. (In reality, that tax-loss makes your performance even higher than 7% because of the economic value of deducting that tax-loss on your tax return, but that’s a whole other topic.) If you think about it, tax gain and loss isn’t a true measure of performance because it has a very narrow purpose: to determine how much capital gain tax liability you would have upon selling an investment. Keep in mind, however, that it’s not a measure of all the taxes you would owe throughout time on an investment, because interest and dividends are taxed over the duration of the investment. It’s a very useful metric to assess the consequences of selling an investment, and to remain efficient with regards to capital gains taxes. But it’s not always an accurate portrayal of total return. I was inspired to write about the difference between these two performance metrics because an investment that many of our clients currently hold is showing a tax loss of roughly -5% but a principal gain of over 30% due to reinvested distributions. Basically, any investment into which you are reinvesting income payments could show both a tax loss and a principal gain. One unfortunate shortcoming of principal gain and loss is that it focuses on “principal”, and therefore does not include profit made from interest and dividends that are not reinvested. For investments into which we do not reinvest dividends, such as individual stocks, be mindful to include all dividends earned over time in your performance assessment. IRR, or “Internal Rate of Return,” does include dividends earned over time, and we will discuss IRR in our second discussion of performance metrics in a later weekend reading. Before our send-off, let me talk about the web for a moment. By default, Investor 360 shows “Principal Gain and Loss.” If you want to see “Tax Gain and Loss,” or a wide range of other statistics that are not shown by default, navigate to the “Holdings” tab on the website and click the “Layout” link in the grey bar above and to the right of the pie chart. From that link, you can add (or remove) many different types of metrics and measures. Indeed, our website is much more powerful than many realize and is built to be as simple, or as sophisticated, as you would like it to be. So, that’s it. Was I able to keep your attention? If so, let’s play some trivia: Can a qualified charitable distribution be used to satisfy all or part of your required minimum distribution, so that you won’t have to pay taxes on the amount distributed? Is this fact or fiction? The answer shall be revealed next week. :) Have a lovely weekend.
Matthew Ramer, AIF® Principal, Financial Advisor MOR Wealth Management, LLC 1801 Market Street, Suite 2435 Philadelphia, PA 19103 P: 267.930-8301 | c: 215-694-4784 | f: 267.284.4847 | 601 21st Street, Suite 300 Vero Beach, FL 32960 P: 772-453-2810
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