The Taxable Investor's Manifesto

CHAPTER SEVENDon't Be Misled by Performance

Business leaders rely on Key Performance Indicators (KPIs) to keep tabs on their enterprises. Taxable investors should do the same. But too often, the metrics used by taxable investors, if they are used at all, are flawed. The investment industry standard for measuring managers of liquid investment portfolios of stocks, bonds, and other publicly traded securities – including hedge funds – is the Time-Weighted Rate of return (TWR); for private investment portfolios like leveraged buyout, venture capital, and real estate funds, the standard is pretax Internal Rate of Return (IRR).¹ Such measures may be fine for tax-exempt institutional investors, but for us taxable investors, these are necessary but insufficient. Even though they are the industry standard KPIs, neither captures the impact of taxes.

FIGURE 7.1 GROWTH OF $100², JANUARY 1, 1999, TO December 31, 2018.

Figure 7.1 shows the dollar growth of three portfolios of publicly traded equities with identical TWRs, but with different investors and different tax profiles.

The top track record in black shows the dollar return for a tax-exempt investor, who is indifferent to whether profits come in the form of income, dividends, short-term, or long-term capital gains. The light and dark gray track records are for taxable investors. The dark gray track record is for a portfolio managed ...