Tax-Hike Threats Put ETF Investors On Edge

November 21, 2012

Revamping the U.S. tax code for the first time since 1986 is a multiheaded hydra, but dividend and capital gains loom as the most pressing concern for investors.


The world of investments is abuzz about what the possibility of higher taxes might mean for investors next year and beyond, but at the end of the day, the uncertainty that the market abhors is perhaps the biggest concern as advisors nervously wait to see what politicians in Washington, D.C., end up doing.

Yes, some investors are taking money off the table in preparation for the possibility of both a higher long-term capital gains rate and even an increase in the amount dividends are taxed.  Indeed, through all the possible permutations of what looks like the most ambitious re-tooling of U.S. tax code since 1986, the fate of capital gains and dividend taxes loom most largely, analysts agree.

Still, plenty of others aren't doing anything at all because they either don't want to second-guess lawmakers, or because they see taxes as less important than simply staying the course.

But as ConvergEx Group’s market strategist Nicholas Colas said, recent outflows from equities mutual funds accompanied by inflows into equities ETFs tell the tale of investors choosing to take a tax hit now in expectation that the long-term cap-gain rate will almost surely jump higher than the current level of 15 percent. But, just as quickly, they’re keen on rolling back into similar, but cheaper, positions using ETFs.

“People are getting out of mutual funds they’ve been in for years, but they want to keep their allocation the same, so they are switching into ETFs,” Colas told IndexUniverse recently. “We know tax rates are unsustainable, so we are going to see mutual fund outflows and ETF inflows accelerate between now and the end of the year,” Colas said, arguing that is likely to fuel an acceleration of ETF inflows.

‘You’ve Got To Do The Math’

Putting off any decision about taking capital gains is especially true for those with longer holding periods and for whom the calculation is a bit more complex.

“Anyone who will have to realize capital gains in the next three or so years, should take them now,” Larry Swedroe, the Research director at BAM Alliance—the entity that encompasses all $18 billion in assets directly or indirectly linked to Buckingham Asset Management—told IndexUniverse in an interview this week.

“But, you’ve got to do the math,” he added. “If it’s 20 years, you probably don’t want to do it, because then you get that continued deferral, and who knows what the tax rate will be in 20 years when you take the money out?”

“On the other hand if it’s four five years, you do the math and you make a decision,” Swedroe said, stressing that given all the variables in play, now is truly a time for investors to consult a tax professional to help them make all the right calls.

Taking Measure Of The Possibilities


IndexUniverse Analyst Carolyn Hill earlier this year outlined just how much higher taxes on things like dividends, interest, and short- and long-term capital gains could be if Obamacare does indeed get rubber-stamped, which looks like a pretty sure deal given that the president was re-elected.

Taxes would be going up by 3.8 percentage points on all joint filers with adjusted gross income of more than $250,000, and on single filers with incomes over $200,000—changes that would take effect a full year before the health law is scheduled to kick in, Hill said in a blog last summer.


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