Backtest Results
To quantify the differences between specific lot versus FIFO accounting, we simulated a tax-managed U.S Large Cap account (top 500 stocks) over 10 years from March 2007 to February 2017. We also looked at the two five year sub-periods and cases where we add or withdraw 5 percent of the initial portfolio value each year as a cashflow.
Over 10 years, our simulations showed a tax benefit of 2.43 percent when using specified-lot accounting. (This level of tax benefit assumes an account that starts with cash, after-tax returns calculated on a pre-liquidation basis, highest federal tax rates, and a taxpayer that has short-term capital gains that can be offset by losses generated by the portfolio. Our typical guidance is to expect tax alpha of 1 to 2 percent per year averaged over a ten-year period.) Tax alpha was higher in the first five-year period (which contained the global financial crisis) and lower in the second five-year period (largely a bull market). The key result in Figure 1 is that the tax benefit that comes from active tax management is only reduced by 5 to 14 basis points per year under FIFO.
Adding cash increased tax alpha by 13 bps for specific lot and only 8 bps for FIFO. Regular withdrawals reduced tax alpha for both by about the same amount, close to 60 bps. Tracking error and turnover are similar. The full results can be found in the appendix. Figure 2 shows the year-by-year realized capital gain/loss results for the five years ending February 2017. There is a similar pattern of gains and losses for specific lot and FIFO.
