The Tax Bill You Pay Without Knowing It

06/04/26

Most people don’t think about their taxes until April each year. But there's a quieter tax issue that affects a lot of investors, one that shows up in taxable brokerage accounts. It's called tax drag, and it can cost you more than you'd expect.

Turnover Ratio

Even if you didn't sell a single share last year inside of a taxable brokerage account, your mutual funds may have sold stocks inside of the fund and passed those capital gains to you. This happens often in funds with a high turnover ratio, meaning those funds are “turning over their portfolio” each year by selling stocks and purchasing new ones.

You will receive a 1099 in January, owe taxes on gains you never actually received as cash, and there's nothing you can do about it after the fact. It's one of the quirks of how mutual funds work. It doesn’t mean you can’t own mutual funds, but there could be other funds or ETFs that are more appropriate for your situation.  

Dividend Reinvestment Adds Up

Automatically reinvesting dividends is usually a smart move for long-term growth. But each reinvestment with a taxable brokerage account is a taxable event, and over time those small amounts add up to a more complicated cost basis and a bigger tax footprint than most people realize.

Again, it is not a reason to stop reinvesting, but it is a reason to pay attention to where dividend-heavy holdings are sitting.

Asset Location

The accounts you hold investments in matter just as much as what you hold. Tax-inefficient assets like high-dividend funds and actively managed funds with a high turnover generally belong inside tax-advantaged accounts like IRAs. Retirement accounts like IRAs have special rules that exempt you from paying capital gains taxes, so turnover ratios don’t make a difference in those accounts.

Growth-oriented, low-turnover investments are better suited for taxable accounts. This simple reshuffling, called asset location, can reduce what you owe each year without changing your overall portfolio strategy.

The Bottom Line

Tax strategy isn't just a year-end conversation. The decisions you make about account structure and investment placement throughout the year quietly determine a big part of your tax bill. If you haven't reviewed your taxable accounts with this lens, it's worth doing.

*Do not use this as advice about your specific situation. Please contact me to talk about your specific situation. You are never charged for meetings or advice.