Don’t Let The “Tax Tail” Wag the Dog

Good Morning Relaxing Retirement Subscriber,

Over the last few weeks, we’ve been discussing an incredible statistic reported by DALBAR, a Boston based research firm.

They revealed the fact that while the S&P 500 index earned 8.19% per year over the last 20 years, the average annual return of the “average” equity mutual fund investor (not investment, but an investor, i.e. a person) was only 4.67%

This means that that average investor earned 43% less than the market index, a measure of average returns, not above average!

43% less each and every year!

Since then, I’ve revealed several big reasons why this ugly phenomenon exists.

In this Retirement Coach Strategy of the Week, I’m going to finish off by revealing a huge contributor to this massive underperformance problem.

And, it may very well come as a surprise to you.

Letting the Tax Tail Wag the Dog

Let me explain what I mean by walking you thru a real life Case Study of an employee of GE:

  • Ted was an employee of GE for 39 years
  • He purchased GE stock shares through payroll deduction during his entire career
  • As a result of purchases and stock splits, when Ted retired on December 1, 2006, he owned 48,000 shares!
  • At $35.28 per share, the value of his shares at that time was $1,693,440
  • What’s important to note is that these GE shares represented 58% of Ted’s investments!
  • The next important fact was that his cost basis in the GE shares (i.e. what he paid for them) was only an average of $12 per share, or $576,000

Question #1 to Contemplate: Is it a good idea for Ted to have 58% of his investments tied up in any one stock?

Question #2: If Ted had $1,693,440 in cash today, should he buy $1,693,440 of GE shares?

Question #3: If the answer is NO, why would Ted then hold on to them and not diversify?

The Answer: Taxes!

Because his cost basis was only $576,000 if he sold the shares back on December 1, 2006 when he retired, Ted would have paid approximately $279,360 in federal and state capital gains taxes, and walked away with $1,414,080.

Ted’s focus was on the $279,360 he had to pay to free up the money and diversify.

He would have been far better off focusing on the fact that he had to part with 16.5% in order to free up the other 83.5%. ($279,360 is 16.50% of the total value of his shares of $1,693,440)

It sounds a lot better.

So, what did Ted do?

Like the overwhelming majority of retirees, Ted hung on to his GE shares to avoid paying any taxes.

Now, let’s take a look ahead to today and see how good of an idea that was.

  • If Ted sold the shares back in December, 2006, paid the tax, and reinvested the remaining $1,414,080 in a simple, generic diversified S&P 500 Index Fund like Schwab’s, the value would have grown to approximately $2,170,198 today assuming he reinvested all dividends (October, 2016).
  • However, he would then have to pay capital gains taxes again of $189,028 upon the sale of the S&P 500 Index Fund, so he would have ended up with approximately $1,981,165 today after taxes if he had sold his GE shares back in 2006, paid the taxes, and reinvested in a basic diversified equity index fund instead.

Let’s now look at where Ted is now since he didn’t sell his GE shares back in December, 2006 in order to avoid paying taxes.

  • If he continued to hold GE shares, including reinvesting the dividends, his shares are worth $1,390,320.
  • When he sells them, he still has to pay the capital gains taxes that he’s been trying to avoid all along. Those would total approximately $203,520 leaving him with a “net” balance of $1,186,560.

To recap, had he sold his GE shares back in 2006, paid the taxes, and reinvested, he would have $1,981,165 (the after tax proceeds of the 500 Index fund shares sold in October 2016).

However, because he let taxes drive his investment decision back in 2006, today he only has $1,186,560 (the value of his GE shares today minus capital gains taxes).

The Penalty for Letting the Tax Tail Wag the Dog

If you do the math, that’s $794,605 that Ted lost because he “Let The Tax Tail Wag The Dog” instead of using sound, rational judgment.

Ted focused on the dollar amount that he had to pay in taxes back in 2006, i.e. $279,360. I agree that’s extremely painful (and the fairness of it is another topic we won’t touch today).

However, by focusing on that dollar cost, he drastically increased his risk and lost more than three times as much!

This is a classic example that I’ve personally witnessed time and time again. And, it’s one of the great lessons of why the average investor not only doesn’t beat market averages, but instead, as statistics have now shown, earns 43% LESS.

Stay out of the trap! Evaluate the tax consequences and the investment consequence simultaneously!

Committed to Your Relaxing Retirement,

Jack Phelps

The Retirement Coach
P.S.: WHO do you know who could benefit from receiving my Retirement Coach “Strategy of the Week”? Please simply provide their name and email address to us at Or they can subscribe at
I appreciate the trust you place in me. Thank you!
(The content of this letter does not constitute a tax opinion. Always consult with a competent tax professional service provider for advice on tax matters specific to your situation.)