Working with Taxes

Taxes are a vital consideration when preparing asset allocations.  The Optimizer offers two methods for working with taxes in an optimization framework: the Basic Method, which adjusts returns and standard deviations based on taxes, and Tax Lots. In addition, the Optimizer offers a tax deferment tool that works in concert with the basic method. New Frontier developed these methods based on client suggestions and welcomes additional client input on this subject. Access the various tax methods through the Taxes Menu.  

The Optimizer handles taxes assuming a single period optimization framework, but another NFA application forecasts the multi-period implications. NFA's LifeCycle application produces a multi-period forecast based on single period return and risk expectations. So, if you load a tax-optimized Optimizer case, LifeCycle automatically applies taxes to the multi-period forecast.

Do use taxes thoughtfully. A model that includes municipal bonds may forecast a capital gain in addition to the normal yield of the bonds. However, in early 2009 many municipal bonds were trading at a significant discount and only the coupons were tax-exempt, so some users adjusted the after-tax mean and standard deviation for these bonds as well. Tax models do not currently account for options, so proper care must be exercised when using these features with options in interpreting the results. They can still be used, but must be interpreted carefully.