Tax Drag
The reduction in compound return caused by paying taxes on investment income or realized gains along the way rather than deferring them until final sale. Every dollar paid in tax during the holding period is a dollar that cannot compound for the rest of that period, so even small annual tax drags (30-50 bps) accumulate to materially smaller terminal wealth over multi-decade horizons. Tax-efficient ETFs minimize tax drag through in-kind redemption; mutual funds in taxable accounts typically run 50-200 bps of annual tax drag depending on turnover.
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Related terms
Adjusted Cost Basis · Annuity · Capital Gains Distribution · Capitalized Interest · Cost Basis · Dividend Discount Model (DDM)
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