"The fact that Uncle Sam is a silent partner in our investment portfolios is painfully clear during tax time, but is often forgotten as investors evaluate success or failure at other times of the year," says Swanson. "It's not what you might make, it's what you keep that matters."
While it is apparent that paying taxes reduces wealth over time, the nature and magnitude of that reduction might surprise some, according to Swanson. He studied historic return data for large cap U.S. equities based on the growth of $1 invested in 1926, demonstrating the significant impact of taxes on portfolios.
Swanson explains the four key lessons from this exercise, which include the effect of regular trading on portfolio returns.
* Taxes matter. The differences in after-tax wealth between a tax-exempt investor and one with a long-term strategy are notable. The tax-exposed investor experienced a reduction in return of more than 0.8 percent annualized over the 78-year period, resulting in wealth of about half of what a tax-exempt investor accumulated.
* Trading has a price tag. Paying capital gains taxes reduces end-of-period wealth relative to investors who employ a strict buy-and-hold strategy. As long as the gains are ultimately taxed at the same rate, the "tax penalty" for active management is relatively modest in terms of annual returns, but still accumulates to real money if trading is very active.
* Short-term strategies are costly. The difference in returns between an investor with long-term trading activity -- 25 percent turnover annually -- compared to that of a short-term trader -- 100 percent turnover annually -- reveals that you must carefully consider short-term tactics.
If adopting a strategy likely to generate significant short-term gains, you must have confidence that it will deliver significantly higher rates of return. If not, you're making Uncle Sam happy while shooting yourself in the foot.
* 2003 tax law changes were a big deal. Examining returns for each type of investor under today's tax laws, compared to these same strategies based on the laws in place immediately before the 2003 changes, clearly shows the impact of this legislation.
The reduction in dividend and capital gains taxes elevated the returns of all strategies by more than 1 percent annualized over the period. That amounts to a more than doubling of end-of-period, after-tax wealth over the course of a lifetime. How to reach: National City,www.nationalcity.com