Most investors spend a lot of time thinking about fees. And that makes sense. Fees matter, and keeping investment costs low is a smart habit. But there is another cost that tends to fly under the radar, and research suggests it is doing more damage to portfolios than fees ever will.
That cost is taxes.
According to a recent industry analysis of investor portfolios, the average annual tax cost is approximately 1.15% of portfolio value. The average portfolio fee, by comparison, sits around 0.37%.¹ That means taxes are costing the typical investor roughly three times more than what they pay to manage their money. And for most people, that gap goes completely unnoticed.
If you have never looked at your portfolio through a tax lens, now is a good time to start.
The Hidden Problem with Actively Managed Mutual Funds
One of the most common sources of unexpected tax bills is something most investors never anticipate: capital gains distributions from actively managed mutual funds.
Here is the issue. Even if you never sell a single share, you can still owe taxes. Mutual funds are required to distribute dividends and realized capital gains to their shareholders each year. Those distributions are taxable in any account that is not tax-advantaged, meaning a standard brokerage account.
In 2024, 76% of U.S. active equity mutual funds paid out capital gains to shareholders, with distributions averaging 7.5% of net asset value.¹ For an investor holding a $1 million position in one of those funds with a combined federal tax rate near 23.8%, that could mean roughly $17,850 in taxes in a single year, on gains you may not have planned for, expected, or even realized were happening.
Exchange-traded funds, commonly known as ETFs, tend to handle this very differently. Because of the way they are structured, ETFs distribute capital gains far less frequently than mutual funds do. Over the past five years, only 17% of active ETFs paid out capital gains, compared to 76% for active mutual funds.¹ For investors who hold taxable brokerage accounts, that difference has real, measurable implications over time.
Four Tax-Smart Strategies Worth Knowing
Getting more intentional about taxes does not require overhauling your entire portfolio. It starts with understanding a handful of strategies and making sure they are actually being applied to your situation.
1. Tax-Loss Harvesting
When parts of the market decline, there is a planning opportunity that can come out of the bad news. Tax-loss harvesting involves selling investments that have dropped in value and using those losses to offset taxable gains you have realized elsewhere in your portfolio.
If your losses exceed your gains in a given year, you can use up to $3,000 of the remaining loss to offset ordinary income. Losses beyond that amount can be carried forward indefinitely to future tax years.²
One important rule to keep in mind: the IRS wash-sale rule. If you sell a security at a loss and then repurchase the same or a "substantially identical" security within 30 days before or after that sale, the IRS will disallow the loss.³ The practical solution is to replace the sold investment with something similar but not identical, so you remain invested in the market while still capturing the tax benefit.
It is also worth noting that tax-loss harvesting only works in taxable brokerage accounts. It cannot be used inside IRAs, Roth IRAs, or 401(k) plans.
2. Asset Location
Asset location is one of the most underused strategies in personal financial planning, and the concept is straightforward. Where you hold an investment can be just as important as what you hold.
Some investments generate income that is taxed at ordinary income rates every single year. Taxable bond funds and real estate investment trusts, for example, tend to throw off regular income that the IRS taxes as ordinary income. Those investments are often better suited for tax-deferred accounts like a traditional IRA or 401(k), where the income is not taxed until you take a withdrawal.
Broad stock index funds, on the other hand, tend to generate qualified dividends taxed at lower rates and produce fewer annual capital gain distributions. Those often make sense in a taxable brokerage account.
The goal of asset location is to reduce what gets taxed each year without changing the overall risk or makeup of your portfolio. It is a strategy that does not require moving much, but it can meaningfully reduce ongoing tax drag over time.
3. Roth Conversions
A Roth conversion involves moving money from a traditional IRA or pre-tax 401(k) into a Roth IRA. You pay income tax on the amount converted in the year you do it, but from that point forward the money grows tax-free, and qualified withdrawals in retirement are also tax-free.
Roth conversions tend to make the most sense in years when your income is lower than usual, which creates an opening to convert at a lower tax rate. For 2026, the 12% federal income tax bracket for married couples filing jointly applies to taxable income between $24,800 and $100,800.⁴ Converting up to that threshold can be a practical way to gradually move money into a Roth at a relatively modest tax cost.
Market downturns can also create good conversion windows. When account values are temporarily lower, converting the same number of shares means fewer taxable dollars, and any recovery that happens afterward occurs inside the Roth, tax-free.
It is also worth noting that for 2026, married couples filing jointly with taxable income up to $98,900 may qualify for the 0% federal rate on long-term capital gains.⁵ In years when income is relatively low, this threshold can open up additional tax planning opportunities around both investment sales and Roth conversions at the same time.
4. Municipal Bonds for Higher-Income Investors
For investors in higher federal tax brackets, municipal bonds can be worth a closer look. The interest income from most municipal bonds is exempt from federal income tax, and in many cases it is also exempt from state income tax if you hold bonds issued in your home state.⁶
Investors in the 24% federal bracket or higher often find that the after-tax yield on municipal bonds compares favorably to taxable bonds, even when the stated interest rate appears lower on paper. For 2026, the 24% bracket for married filing jointly begins at $211,400 in taxable income.⁴ At that level of income and above, the tax exemption on muni bond interest can make a meaningful difference in what you actually take home.
After-Tax Returns Are What Actually Matter
It is easy to focus on what your portfolio earned. What is harder, but more important, is focusing on what you actually kept after taxes were paid. Over long periods of time, those two numbers can look quite different.
Taxes are one of the few costs in investing that you actually have some control over, at least partially. You cannot control what the market does. You cannot control interest rates or inflation. But with thoughtful planning, you can influence how much of your return ends up in your pocket rather than going to the IRS.
That is why we believe tax planning belongs inside your investment strategy, not separate from it.
How We Can Help
At Dreyer Wealth Management, reviewing your situation through a tax lens is part of how we look at the overall financial picture. That means understanding what you hold and where you hold it, watching for tax-loss harvesting opportunities throughout the year, and coordinating with your tax professional when strategies like Roth conversions make sense for your situation.
We cannot eliminate taxes. But with careful planning, we can help make sure you are not paying more than you need to. If you would like to talk through how your current portfolio looks from a tax efficiency standpoint, we would welcome that conversation. Feel free to reach out to our team at any time.
Sources
- BlackRock Tax Center. "Build Tax-Efficient Portfolios." Proprietary portfolio analysis and Morningstar data, including five-year average percentage of active funds paying capital gains distributions from 2021 through 2025. Data as of December 31, 2025. https://www.blackrock.com/us/financial-professionals/insights/tax-center
- Internal Revenue Service. Publication 550: Investment Income and Expenses. Capital loss deduction rules, including the $3,000 annual limit for offsetting ordinary income and indefinite carryforward of excess losses. https://www.irs.gov/publications/p550
- Internal Revenue Service. IRC Section 1091, Wash-Sale Rule. Prohibition on claiming a loss when a substantially identical security is purchased within 30 days before or after the date of sale. https://www.irs.gov/publications/p550
- Internal Revenue Service. Revenue Procedure 2025-32. 2026 federal income tax rate schedules and inflation-adjusted bracket thresholds. The 12% bracket for married filing jointly applies to taxable income from $24,800 to $100,800. The 24% bracket begins at $211,400 for married filing jointly. https://www.irs.gov/pub/irs-drop/rp-25-32.pdf
- Kiplinger / Internal Revenue Service. 2026 long-term capital gains tax thresholds. The 0% rate applies to taxable income up to $98,900 for married couples filing jointly, per IRS Revenue Procedure 2025-32. https://www.kiplinger.com/taxes/irs-updates-capital-gains-tax-thresholds
- Internal Revenue Service. Publication 550: Investment Income and Expenses. Tax treatment of municipal bond interest, including federal income tax exemption and state exemption considerations. https://www.irs.gov/publications/p550
This blog post is for informational and educational purposes only and does not constitute investment, tax, or legal advice. Tax rules are complex and individual circumstances vary. Please consult a qualified tax professional before implementing any of the strategies discussed. Past performance does not guarantee future results.