What’s more important: the pre tax or after tax return?

When you’re researching an investment, one of the first things you look for is how it has performed over time. Generally, the investment promoter will highlight the most attractive figure to draw you in – the headline return – and have the after-tax and fees return in smaller print where it’s difficult to spot. By just focusing on an investment’s pre-tax returns, investors may miss out on the most important aspect of an investment and that is how much you get to keep after you pay tax.

While tax shouldn’t be the sole motivator for choosing investments, it is important to be aware of the difference between headline and after-tax returns. And it’s not just the high-net-worth investors that need to be concerned. Most investors want their portfolios to be as tax efficient as possible: the less that you pay in tax, the more that is available to re-invest or to receive back in your hands. And by knowing the after-tax performance of an investment, you can see if your investment is growing or if the fees and taxes are eroding the outperformance advertised in the headline rate.

An understanding of the different types of returns also requires an awareness of the different strategies adopted by fund managers and where tax fits in with them. For example, a very active investment strategy, with higher stock turnover, will have a higher tax impact on a fund than a passive strategy because the active managers tend to buy and sell more frequently – crystallising capital gains on which tax is payable by investors in the form of a taxable distribution. This may be worthwhile if the greater returns expected from an active strategy are covering the tax payable generated by this process, which is another reason why it’s important to know what the after-tax returns are. After-tax performance takes into account the realised and unrealised gains and losses of the investments as well as any imputation credits from share dividends, tax deferred income from property investments and other allowable tax deductions. Typically, cash type investments, such as term deposits, bank bills and international shares, have no tax benefits to pass on to investors, whereas Australian shares, property syndicates and AREITs do have tax benefits.

Typically, index funds tend to be more tax efficient than active funds because for the most part they buy and hold the stocks in the benchmark index in whose performance they wish to replicate. As a result, the turnover is low.

Over time, the difference in the tax-effectiveness of investments can have a very significant impact on your overall wealth creation. Therefore, it makes sense to pay attention to the after-tax return figures and not compare them to other pre-tax performance figures. While past performance is never an indicator of future performance, a tax-efficient fund is more likely to return more of its growth to investors than one that doesn’t take tax efficiency into account.

A clearer picture of performance is available with investment bonds. Investment bonds are a tax-paid investment where the bond provider pays the tax on the underlying investments at 30% less deductions and franking credits. Unlike shares, term deposits or managed funds, performance returns are quoted net – or after the payment of fees and taxes by the provider, such as Centuria Life with its recently launched LifeGoals product.

Like superannuation during the life of the investment, there is no need to include the earnings in your personal tax return, unless you withdraw in the first 10 years, making them very simple to manage from an administration point of view. Unlike superannuation, you can access the funds any time. If you do withdraw funds in the first 10 years, you receive a 30% tax offset for the tax the fund has already paid. You can choose from an investment menu of high-quality actively managed funds that best align with your risk/return profile.