Insights &
Perspectives.

Tax drag is the annual return lost to taxes on investment distributions — dividends and realized capital gains. It does not apply to your entire return, only to the portion actually distributed and taxed in a given year. A high-turnover active fund can easily create over 1% of annual drag on an otherwise solid return, and compounding that loss quietly erases six figures over a decade.

Two things trigger taxes each year: income distributions (dividends, interest) and capital gains distributions driven by fund turnover. Unrealized price appreciation is never taxed annually — it compounds untouched until you sell. The drag is calculated on only those two distributed amounts, multiplied by your blended tax rate.

When a fund sells holdings to rebalance or replace positions, it realizes capital gains and distributes them to shareholders — creating a taxable event even if you never sold a share yourself. A fund with 65% annual turnover is effectively realizing and distributing the majority of its price appreciation each year. An index ETF at 5% turnover barely triggers any distributions at all.

Look up the annual turnover ratio on each fund you hold — it's published in the fund's prospectus or on Morningstar. Pair that with your effective rate on investment gains (long-term rates are 15–23.8% for most high earners; short-term gains are taxed as ordinary income). High turnover combined with a high tax bracket is where drag becomes most severe.

Assets inside tax-deferred and tax-free accounts grow without any annual drag — gains compound untouched. This estimator focuses on taxable brokerage accounts, where the drag is most visible. A significant part of our planning work is deciding which assets belong in which account type, a strategy called asset location, to minimize drag across the whole portfolio.

The most impactful tools are direct indexing (owning individual stocks so losses can be harvested at the lot level without triggering distributions), tax-loss harvesting to offset realized gains, asset location to shift income-heavy holdings into tax-deferred accounts, and deliberate use of low-turnover strategies that defer gains rather than distribute them annually.