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Primary Article

Diversification in the Presence of Taxes

David M. Stein, Andrew F. Siegel, Premkumar Narasimhan and Charles E. Appeadu
The Journal of Portfolio Management Fall 2000, 27 (1) 61-71; DOI: https://doi.org/10.3905/jpm.2000.319784
David M. Stein
The chief investment officer and managing director at Parametric Portfolio Associates in Seattle (WA 98104).
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Andrew F. Siegel
The Grant I. Butterbaugh professor of finance and management science at the University of Washington in Seattle (WA 98121).
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Premkumar Narasimhan
The director of research and advanced technology at Parametric Portfolio Associates in Seattle (WA 98104).
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Charles E. Appeadu
An assistant professor of finance at Georgia State University in Atlanta (GA 30303).
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Abstract

A common problem for taxable investors is how much to diversify either a low cost basis single–asset or concentrated portfolio. While tax–exempt theory is clear on the benefits of diversification, and there are useful industry methods for addressing this, in the presence of taxes there are no standard approaches to arriving at a considered choice. The authors propose an analytic and intuitive framework for addressing the problem, considering only two investment alternatives. By defining a tax–deferred equivalent of the taxable investor, they are able to adapt standard analytical methods and view the diversification decision in the presence of taxes as a conventional risk–return trade–off, provided the appropriate tax–deferred performance measures are used. Greater diversification is needed with greater initial asset volatility, with longer investment horizons, with lower expected return of the initial asset, and with a higher cost basis. Less diversification is needed when the investor receives a step–up in basis at the horizon. The results highlight the substantial risks incurred in concentrated holdings and often support high levels of diversification, even in the face of taxes.

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Diversification in the Presence of Taxes
David M. Stein, Andrew F. Siegel, Premkumar Narasimhan, Charles E. Appeadu
The Journal of Portfolio Management Oct 2000, 27 (1) 61-71; DOI: 10.3905/jpm.2000.319784

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Diversification in the Presence of Taxes
David M. Stein, Andrew F. Siegel, Premkumar Narasimhan, Charles E. Appeadu
The Journal of Portfolio Management Oct 2000, 27 (1) 61-71; DOI: 10.3905/jpm.2000.319784
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