Stocks for the Long Run : the Definitive Guide to Financial Market Returns and Long-term Investment Strategies

Despite the debilitating effect of taxes on equity accumulations,

taxes cause the greatest damage to the returns on fixed-income invest-

ments. On an after-tax basis, an investor in the top tax bracket who put

$1,000 in Treasury bills at the beginning of 1946 would have $138 after

taxes and after inflation today, a lossin purchasing power of more than

86 percent. Instead, a highest-bracket investor would have turned $1,000

into over $5,719 by buying stocks, a 470 percent increase in purchasing

power.

In fact, for someone in the highest tax bracket, short-term Treasury

bills have yielded a negative after-tax real return since 1871, even lower

if state and local taxes are taken into account. In contrast, top-bracket

taxable investors would have increased their purchasing power in

stocks 269-fold over the same period.

THE BENEFITS OF DEFERRING CAPITAL GAINS TAXES

In May 2003 President George W. Bush signed the Jobs and Growth Rec-

onciliation Act of 2003, which reduced the highest tax rate on qualified

CHAPTER 5 The Impact of Taxes on Stock and Bond Returns 69

TABLE 5–1

After-Tax Real Asset Returns, 1802 through December 2006: Compound Annual Rates of Return (%)*

Bonds Bills

$0 $50K $150K Max $0 $50K $150K Max $0 $50K $150K Max

1802-2006 6.8 5.9 5.6 5.2 3.5 2.8 2.6 2.3 2.8 2.3 1.8 1.5 3.0 0.3 1.4

1871-2006 6.7 5.4 4.9 4.2 2.8 1.8 1.5 1.0 1.7 0.9 0.2 -0.3 2.0 0.4 2.1

1913-2006 6.3 4.4 3.7 2.8 1.9 0.5 0.0 -0.7 0.5 -0.6 -1.6 -2.3 0.9 0.4 3.3

I 1802-1870 7.0 7.0 7.0 7.0 4.8 4.8 4.8 4.8 5.1 5.1 5.1 5.1 5.0 0.2 0.1

II 1871-1925 6.6 6.5 6.4 6.2 3.7 3.7 3.6 3.4 3.2 3.1 3.0 2.7 3.4 -0.8 0.6

III 1926-2006 6.6 4.4 3.7 2.8 2.2 0.6 0.0 -0.6 0.7 -0.6 -1.6 -2.3 1.1 1.2 3.0

1946-2006 6.8 4.3 3.4 2.9 1.4 -0.6 -1.2 -1.7 0.6 -1.1 -2.5 -3.2 0.5 0.5 4.0

1946-1965 10.0 7.0 5.2 3.8 -1.2 -2.0 -2.7 -3.5 -0.8 -1.5 -2.3 -2.7 -0.6 -2.7 2.8

1966-1981 -0.4 -2.2 -3.0 -3.3 -4.2 -6.1 -7.0 -7.5 -0.2 -3.0 -5.2 -6.1 -1.0 8.8 7.0

1982-1999 13.6 9.4 9.1 9.1 8.4 4.9 4.5 4.4 2.9 0.8 -0.8 -1.7 2.7 -4.9 3.3

1982-2006 9.0 6.4 6.3 6.2 7.3 4.5 4.2 4.0 2.1 0.4 -0.9 -1.7 2.2 -1.2 3.1

*Federal income tax only. Assume one-year holding period for capital gains portion of return.

Muni

Bds Gold CPI

Postwar Periods

Major

Subperiods

Period

Stocks

Tax Brackets Tax Brackets Tax Brackets