April 09, 2026
As the end of tax season approaches, it’s a natural time to reflect not just on what you owe, but on how taxes impact your long-term investment outcomes. Thoughtful tax planning isn’t just an annual exercise, it’s also an ongoing part of building and preserving wealth.1
Taxes are often overlooked, yet they play a critical role in investment outcomes. In taxable accounts—such as brokerage accounts and trusts—returns are ultimately realized in after-tax dollars, even though many projections focus on pre-tax performance. To manage this effectively, investors should focus on three key factors: asset location, investment structure, and tax drag.
Asset location refers to the type of account holding an investment. Broadly, these fall into two categories of accounts: tax-advantaged and taxable.
Tax-advantaged accounts, such as 401(k)s and IRAs, shield investors from current taxes on capital gains, dividends, and interest. In most cases, withdrawals are taxed as income (with the exception of Roth accounts, which are funded with after-tax dollars that can be withdrawn tax-free). This tax deferral allows for more efficient compounding and lower-cost rebalancing over time.
Taxable accounts, by contrast, incur taxes when gains are realized or income is generated. However, they offer important advantages. Long-term capital gains are taxed at lower rates than ordinary income and, in some cases, at 0%.2 In addition, taxable accounts allow for tax-loss harvesting, where realized losses can offset gains elsewhere or reduce a portion of ordinary income each year.
The types of investments used are important to consider. When simplicity and diversification are priorities, the two primary investment vehicles implemented in portfolios are mutual funds and exchange-traded funds (ETFs). Both can hold similar underlying assets, but their tax efficiency can differ materially. If a mutual fund sells a security, or if its shareholders redeem shares, the fund may need to sell underlying holdings in the open market, passing any resulting capital gains on to remaining shareholders.
ETFs are different. They use a creation and redemption process that allows shares to be exchanged “in-kind,” helping reduce or eliminate capital gains while investors hold the fund. Creations typically occur when demand pushes an ETF’s price above its underlying value. In this case, authorized participants (APs) deliver the underlying securities to the fund issuer (e.g., Vanguard or State Street) in exchange for newly created ETF shares. Redemptions work in reverse, with APs exchanging ETF shares for the underlying holdings. This process helps keep the fund’s price aligned with its assets while minimizing taxable events.
Source: www.schwab.com
Tax drag is the reduction in returns caused by taxation—the difference between pre-tax and after-tax performance.3 Investments that generate frequent taxable income, such as bank CDs, high-yield savings accounts or actively traded strategies, tend to experience higher tax drag.
Over time, this drag compounds. Even if two investments generate the same pre-tax return, the one with lower tax exposure can produce significantly better after-tax results.
For example, assuming a $100,000 investment growing at 7.5% with a 20% tax rate, a tax-free portfolio grows to nearly $425,000 over 20 years. A tax-deferred portfolio reaches about 80% of that value, while a portfolio taxed annually realizes only about 68%. The difference is driven entirely by taxation.
**Assumptions: $100,000 starting portfolio balance, 7.5% rate of return, 20% tax rate.
Recent federal tax changes continue to shape planning opportunities for investors. The One Big Beautiful Bill Act (OBBBA), passed in 2025, made permanent many provisions from the 2017 Tax Cuts and Jobs Act.4 Current income tax brackets remain in place, and the standard deduction increased to $16,100 for single filers and $32,200 for married couples in 2026. The cap on state and local tax (SALT) deductions has also been raised, which may impact older taxpayers through an additional deduction.5
Retirement savings limits have increased, with 401(k) contribution limits rising to $24,500 and IRA limits to $7,500.6 New rules also require higher-income earners to make catch-up contributions on a Roth basis, while individuals in their early 60s can take advantage of expanded catch-up provisions. Estate and gift tax exemptions remain elevated, allowing for continued tax-efficient wealth transfer.
At the same time, several energy-related tax credits are expiring or phasing out. Taken together, these changes highlight the importance of revisiting tax strategies and making the most of available planning opportunities.
Tax efficiency extends beyond account structure and investment vehicles. It also includes how companies return capital and when investors choose to act.
Corporate tax regimes and capital allocation decisions can influence after-tax returns. Share buybacks are often more tax-efficient than dividends, as investors typically defer taxes until shares are sold. Dividends, by contrast, are generally taxable in the year they are received.
Timing also plays a critical role. While deferring taxes is often beneficial, it is not always optimal to hold an investment solely to avoid realizing a gain, particularly if the investment is high-cost or underperforming.
Consider an investor with a 20-year horizon who purchased a fund for $10,000 that is now worth $12,000. The fund has returned 9% annually, while a comparable index has returned 10%. If held, the position may grow to approximately $67,253. However, if the investor sells today—paying $400 in taxes—and reinvests the remaining $11,600 into the higher-returning index, the value could grow to $78,039.
While no one enjoys paying too much in taxes, this example highlights an important principle: a modest tax cost today can create significantly greater after-tax value over time.
One of the most valuable steps an investor can take is aligning their strategy with their time horizon. Longer horizons not only enhance compounding but also magnify the benefits of tax efficiency. Taxes paid today are dollars that can no longer compound tomorrow.
Thoughtful asset location, the use of tax-efficient vehicles like ETFs, and disciplined strategies such as tax-loss harvesting can meaningfully improve after-tax outcomes over time. While taxes are often viewed as secondary, they are one of the few variables investors can actively manage.
A well-constructed portfolio isn’t just diversified and low-cost—it is deliberately tax-aware, helping the investor to keep more of what the market provides. As tax season reminds us, thoughtful planning today can help preserve more of those returns over time.
One Day In July LLC is an SEC-registered investment advisor. Registration does not imply a certain level of skill or training. One Day In July LLC does not guarantee actual returns or losses. The content of this newsletter is for educational purposes only and is not investment advice. Individual circumstances may vary.
This newsletter should not be construed as tax advice. Please consult with a tax professional to make decisions concerning such matters.
Sources:
[1] One Day In July, Tax Planning. https://www.onedayinjuly.com/tax-planning-in-your-investment-portfolio
[2] IRS, Capital Gains and Losses. (2025). https://www.irs.gov/taxtopics/tc409
[3] Investopedia, Tax Drag.https://www.investopedia.com/terms/t/tax-drag.asp
[4] IRS, OBBA. (2025). https://www.irs.gov/newsroom/one-big-beautiful-bill-provisions
[5] Tax Foundation, State and Local Tax. https://taxfoundation.org/taxedu/glossary/salt-deduction/
[6] IRS, 401(k) Limit Increases. (2025). https://www.irs.gov/newsroom/401k-limit-increases-to-24500-for-2026-ira-limit-increases-to-7500
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