And for non-registered
investments, how much of that growth is reportable as income each year is
perhaps even more important, since it is the after-tax performance that ultimately
counts. “Tax Efficiency” refers to the proportion of an investment’s
annual growth that is not subject to annual taxation. It also incorporates
the effective tax rates for various types of income, to produce a measure
of how much growth you actually keep.
For instance,
a bank account that produces interest income is only 50% efficient, assuming
a 50% marginal tax rate, since every cent of income is reportable each year,
and that income receives no preferential tax treatment.
Conversely, assuming a personal 50% tax rate, funds that generate dividend
income, rather than interest or capital gains income, will tend to be more
tax efficient, since dividends are taxed at 36% and capital gains 39%.
In general, a “buy and hold” strategy will improve the tax efficiency
of any fund, since a significant portion of the fund growth is in the form
of unrealized capital gains – i.e., paper profits that would only be
reportable if the fund manager sold the underlying securities.
