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Deltaone,

There is one part of your calculation I don't follow, however :

>For x1, this is tricky. Take 10% returns. Let's assume 2% are
>dividends are 8% are capital gains. You'd lose 15% of your 2% of
>dividend in taxes each year. So that's 0.3% off your annual rate
>of return. Then let's assume your average holding period is 4
>years. So 1/4 of your cap gains are sold every year as long term.
>Again at the 15% cap gains rate. This is (1/4) * 8% * 0.15 or
>another 0.30% off your aveage return.

If I buy an investment with an 8% appreciation, after 4 years the principal is worth 1.36 (very slightly more since the 8% is compounded, actually 1.36048896, but let's round it ;)). At the time of sale, I have to pay the 15% capital gains tax on the 0.36 capital gain. That takes 15% * 0.36 = 0.054 off the total return, which leaves a final principal of 1.306 after 4 years. This is an average annualized net return of (1.306 ^ 1/4) - 1= 6.9% . Ie, the taxes reduced the annual capital appreciation from 8% down to 6.9%, or in other words they reduced the annual return by 1.1%, not by 0.3% .

Also, unfortunately in my case, the 15% is only the federal capital gains tax rate. The state of California doesn't have a lower tax rate for capital gains, so they get taxed at the marginal bracket, which is the top 9.3% bracket for me. By account for the deductibility of the state taxes, this means my total capital gains taxes are 9.3% + 15% * (1 - 9.3%) = 22.9 % .

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