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Article

Embedded Tax Liabilities and Portfolio Choice

Phillip A. Turvey, Anup K. Basu and Peter Verhoeven
The Journal of Portfolio Management Spring 2013, 39 (3) 93-101; DOI: https://doi.org/10.3905/jpm.2013.39.3.093
Phillip A. Turvey
is a doctoral student of finance at Queensland University of Technology in Brisbane, Australia.
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  • For correspondence: phillip.turvey@qut.edu.au
Anup K. Basu
is a senior lecturer of finance at Queensland University of Technology in Brisbane, Australia.
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  • For correspondence: a.basu@qut.edu.au
Peter Verhoeven
is an associate professor of finance at Queensland University of Technology in Brisbane, Australia.
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  • For correspondence: peter.verhoeven@qut.edu.au
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Abstract

Taxes play an important role in determining after-tax investment risk and returns, but many practitioners still make investment decisions based on pre-tax values. The apparent complexity of dealing with deferred capital gains and the question of how these implied future tax liabilities should be valued are central to this problem. The authors use a simple arbitrage argument to show that a risk-free discount rate is appropriate for calculating the present value of future tax liabilities. This lets analysts adjust risk and returns for effective tax rates and present a more accurate picture to the investor. The results show a taxation-induced preference for holding equities over bonds and a location preference for holding equities in a taxable account and bonds in retirement accounts. These important findings contrast with traditional investment advice that suggests a greater capacity for risk in retirement accounts.

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The Journal of Portfolio Management: 39 (3)
The Journal of Portfolio Management
Vol. 39, Issue 3
Spring 2013
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Embedded Tax Liabilities and Portfolio Choice
Phillip A. Turvey, Anup K. Basu, Peter Verhoeven
The Journal of Portfolio Management Apr 2013, 39 (3) 93-101; DOI: 10.3905/jpm.2013.39.3.093

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Embedded Tax Liabilities and Portfolio Choice
Phillip A. Turvey, Anup K. Basu, Peter Verhoeven
The Journal of Portfolio Management Apr 2013, 39 (3) 93-101; DOI: 10.3905/jpm.2013.39.3.093
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  • Article
    • Abstract
    • ADJUSTING RISK AND RETURN FOR TAXES
    • DEALING WITH DEFERRED CAPITAL GAINS TAX
    • EMPIRICAL RESULTS
    • SUMMARY
    • ENDNOTES
    • REFERENCES
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