03 Jun 2026 Minimizing “Uncle Sam’s Cut”

Understanding the actual performance of your investment portfolio is harder than it should be. Investments typically show returns net-of-expenses, but often fail to show how much of the gain the expenses consumed. This is especially important when an investor or advisor is using active stock funds, which can have expenses that are 10x as much as passive stock funds.

Where it gets trickier is understanding how taxes impact your performance. Fees are relatively simple: the Vanguard Total Stock Market ETF (VTI), for example, charges 0.03% (or $0.03 for every $100 invested) whether you’re the illustrious financial advisor (and noted Brief-writer) Ryan Smith, or the other Ryan Smith, billionaire owner of the Utah Jazz and the Utah Mammoth. Assuming we had the same investment portfolio, our fees would be the same, but our after-tax returns would be markedly different. The only way to calculate them would be to review our prior year tax returns, parse out how much additional taxation our investments created, subtract that from the dollar gain in our portfolio, then re-calculate the rate of return. I can promise you the other Ryan Smith hasn’t spent an hour on a Saturday morning doing this.

Andrew Ang recently wrote a research paper called “Uncle Sam’s Cut: A Century of the Federal Tax Drag on US Equity Returns.” In it, he tells us that the total U.S. stock market has averaged 10.5% annually over the last 100 years, which is a great figure. Sadly, federal taxes reduced that to 7% and, depending on the state you live in, that number could drop even further. Of course, none of us have been investors for the last 100 years, but many of us have for the last thirty, and Mr. Ang’s research shows a similar tax-bite: “Over the modern 1996-2025 period, $474,600 of starting capital in 1995 dollars (equivalent to $1 million in 2025 dollars) grows to $5,138,809 after Federal taxes, compared with $8,089,323 in the zero-tax benchmark.” Put another way, federal taxes ate nearly 36% of the returns. Below, you can see how taxes have reduced returns (the “tax drag”) over rolling 30-year periods going back to 1926. (Note: “100 bps” is 1%.)

Now, this isn’t a prompt to dodge taxes. I can’t be more clear: You cannot avoid the federal tax code! But you can invest smarter, and I would argue that we, Beacon Wealthcare, excel in this area. Here’s what we do to minimize Uncle Sam’s cut.

Invest Passively

As mentioned previously, not only are active investment strategies more expensive, they also, on the whole, create a far larger tax burden than their passive counterparts. According to Morningstar, the median “tax-cost ratio” for actively managed, large-blend funds over the last three years was 1.28%. Compare that to the Vanguard Total Stock Market Index, which had a tax-cost ratio of .38%. If you stack the difference in fees (roughly 0.5%) on top of the difference in tax-cost, you see that VTI has a meaningful 1.4% head start on performance.

Locate Assets Intentionally

Different assets create different kinds of taxation, and different investment accounts receive different tax treatment. Some retirement accounts, a Traditional IRA, for example, provide a tax-deduction when you contribute then hit you with taxes when a withdrawal is made. Others, like a Roth IRA, provide no immediate income-tax deduction, but offer tax-free withdrawals. Brokerage accounts provide a mix: annual taxation due to dividends and interest, scattered capital gains, and tax-free return of principal.

Some financial planners will invest all three types of accounts the same, looking something like this:

The problems with this approach are many: it puts fixed income, or bonds, in a tax-free (Roth) account, it puts tax-inefficient bonds in a taxable account and, because all accounts are invested the same, placing rebalancing trades in the brokerage account increases taxes.

We choose a smarter approach, commonly referred to as “Asset Location”:

As you can see, each account gets invested differently based on its tax treatment and where we want to concentrate growth. Stocks are consolidated in the the Roth account so the tax-free bucket can appreciate as much as possible and in the brokerage account where the bulk of the gains come from appreciation, which isn’t taxed until an investment is sold. Meanwhile, bonds are stuffed into the tax-deferred account where the income payments are sheltered from taxes. Also, because future withdrawals are taxed as ordinary income, we’re ok with this account growing at a bit slower pace.

As you can see by comparing both images, the overall portfolio allocation on the far left is the same. By being wiser about asset location, we can grow tax-free accounts more and keep tax-inefficient investments in tax-advantaged accounts, reducing both current and future taxation.

Rebalance Wisely

Rebalancing a portfolio is an important risk management technique. As markets move, your portfolio can stray from its target allocation. Periodic rebalancing resets your investment mix to its target.

When all accounts are invested the same, this can be hard to do without adding to your tax bill. Certainly, tax-advantaged accounts like Roth and Traditional IRAs can be rebalanced without worry, but what about the brokerage account? As it wanders from its intended allocation, trades can cause taxation, reducing your after-tax returns. By investing each account differently, we can maintain the appropriate balance between stocks and bonds by placing all rebalancing trades in the tax-deferred account.

There is often a disconnect between the kinds of investments we own, how they are managed, and the impact they have on our tax bill. Mr. Ang’s research reminds us of the importance of awareness. Surrendering 36% of the gains over a 30-year time period is a high price to pay, and while we can’t ever fully avoid taxes, by investing intentionally, we can minimize them.

The content above is for informational and educational purposes only. The links and graphs are being provided as a convenience; they do not constitute an endorsement or an approval by Beacon Wealthcare, nor does Beacon guarantee the accuracy of the information.