The nominal tax drag simplifies to this: Tax Rate x ((1 + return)^Time - 1) so as return or time increase, the value of tax drag increases. So far, so good. The CFAI says this: Because the tax drag in increases with the investment return and time horizon, the value of a capital gain tax deferral also increases with the investment return and time horizon. (Level III Volume 2 Behavioral Finance, Individual Investors, and Institutional Investors , 4th Edition. Pearson Learning Solutions p. 180). The conclusion does not make sense to me. Tax drag is essentially lost money from the investor’s perspective so it is sounds like a loss to me… Intuitively, away from this gobbledygook, the investor is benefiting from tax-free growth of his/her wealth so s/he benefits if return/time horizon increase. I just need some comments on CFAI’s language to help me understand their language…i just want to make sure that i am not losing something here… thanks
Makes sense to me. If you plots cash flows with/without tax, the difference increases as the time horizon and return increase. The longer you avoid paying taxes, the more you can accumulate over time due to compounding effects. You can plot all of this on an Excel spreadsheet, maybe it will be more intuitive if you see the actual effects.
“the value of a capital gain tax deferral” ie: The amount of money you will have to pay in taxes at a later date. This isn’t the perceived value to the investor (which is how I think you were viewing it), but instead the quantitative value of the taxes due when the investor makes a withdrawal.