Dfa Tax Managed Product

Question 4

Tax-managed product

What are the pros and cons of the tax‐managed product?

In the United States dividends were subject to federal taxes at a rate of 39.6% plus state and local taxation, while capital gains were subject to federal taxes at a rate of 28 or 20% (dependent on the holding-term) plus state and local taxation and capital losses were deductable from the gains. This provided DFA with a great incentive to minimize the taxes paid by the clients. The main advantage of the tax-managed product is that it enables DFA to outperform the market and earn higher profits.

However, besides the fact this product is not appropriate for all investors, there are some disadvantages associated with the tax-managed product. At first, in order to exploit the opportunity investors should take transaction costs into account. Every transaction should be weighed against the aimed tax benefit. Next, focusing on a strategy which attaches great importance to tax management will force DFA to pick predominantly non-dividend paying stocks (since dividend is taxed significantly higher than capital gains). This will limit the ability of the fund to diversify. At last, exploiting this opportunity is a complicated task which requires a lot of effort estimating the loss of diversification as a result of tax-benefits.

According to you, is it a good product? Explain.

We consider the tax-managed product as a good product which provides DFA with a major opportunity to outperform the market. However, this applies only when DFA is able to gather a sufficient pool of investors. This product will only succeed when a sufficient amount of money is used. At a small scale, the costs and efforts of implementing this product will be higher than the intended benefits. But, when implemented on a large scale, the decline in tax payment will transcend the efforts and costs associated with this product.