Taxes and the Cost of an Obsession

Dylan Potter, CFA, CFP®, VICE PRESIDENT, WEALTH MANAGER​

“Return on hassle” refers to the concept of evaluating the time and effort required for a financial decision in addition to its expected financial return. Hedge fund manager Bill Ackman has another name for this idea: “Return-on-invested-brain-damage.” If the return isn’t high enough to justify the brain damage or hassle, move on. For real estate investors, this includes the mental and physical labor involved in finding tenants, maintaining properties, and managing debt, among other responsibilities. These are “hassles” that traditional investments like stocks and bonds don’t typically entail. An obsession with tax avoidance is perhaps my favorite topic when considering the “return on hassle.”

Father and child on beach in California

Consider a hypothetical couple who were obsessed with minimizing their tax bill. They invested heavily in tax shelters and complex financial instruments promising tax advantages. Their lives became a spreadsheet nightmare, filled with legal jargon and the constant fear of an IRS audit. They refuse to sell any asset because they hate the idea of paying capital gains taxes. They were so focused on reducing their tax liability that they lost sight of the bigger picture: growing their wealth in a sustainable and less stressful manner.

Their experience is not unique. Many people spend an inordinate amount of time and energy trying to outsmart the tax system. They pay accountants and law firms huge sums; they chase deductions, credits, and tax-deferred accounts to the point where their financial strategies become convoluted. In some cases, the tax payments are almost viewed as worse than investment losses! The irony is that these efforts can sometimes lead to worse financial outcomes. As Charlie Munger said, “Trying to minimize taxes too much is one of the great causes of really dumb mistakes in investing.” Investments chosen for their tax advantages might underperform, and the constant shuffling of assets can incur other costs (i.e. hassle and “brain damage”) that outweigh the tax savings.

There’s a broader issue at play here. When you let taxes dictate your financial decisions, you can lose sight of your true financial goals. The objective of investing is to grow your wealth, achieve financial security, and maybe even attain financial independence. Taxes are a factor, but they should not be the primary driver of your decisions.

Now, let’s look at the story of another couple who made a significant life change driven by the pursuit of lower taxes. They lived in California (insert any high tax state) in close proximity to their friends and family. They had a vibrant social life and enjoyed the beautiful weather. They were close to their grandkids…but they hated the taxes. In their quest to reduce their tax burden, they decided to move to a state with no income tax.

At first, the financial benefits seemed clear. They saved a significant amount of money on their taxes, which they initially used to invest and improve their overall financial situation. However, as time passed, the hidden costs of their decision began to emerge. They missed the social connections they had in California, the weekend family gatherings, and the lifestyle they had grown accustomed to. The new state, though tax-friendly, didn’t offer the same quality of life they had left behind. They realized that while they had gained financially in one aspect, they had lost much more in terms of personal happiness and fulfillment. The lower taxes couldn’t compensate for the sense of belonging and the joy derived from their community and surroundings. They chose financial riches over life riches. They let the tax tail wag the life dog.

Taxes are part of the decision-making equation… but your life shouldn’t be consumed by them! Sometimes, we just have to pay the taxes and move on with our lives. Afterall, are we going to remember the taxes we had to pay or are we going to remember the memories we created with the people we love (and have a drink or two and grumble about the taxes)? Think about the hassle of uprooting your entire life solely to save on taxes. To me, you’ve lost the plot of what is actually important at the end of the day.

Disclosures: The following content is intended for informational purposes only and does not constitute investment advice, legal advice, tax advice, or a recommendation to buy or sell any securities. Investing involves risks, including the potential loss of principal. Past performance is not indicative of future results. You should consult with your own financial advisor, tax advisor, and legal advisor before making any investment decisions. The examples and hypothetical scenarios presented are for illustrative purposes only and should not be considered a guarantee of future results. Individual results will vary, and the examples provided may not reflect the actual experience of any particular investor. Tax laws and regulations are complex and subject to change. The tax treatment of investment strategies may vary based on individual circumstances. You should consult with a qualified tax professional to understand the potential tax implications of any investment strategy. Investments involve risks, including the potential loss of principal. The concept of “return on hassle” or “return-on-invested-brain-damage” is subjective and will vary from one individual to another. The perceived hassle or effort involved in an investment decision is not quantifiable and may differ based on personal experiences and circumstances. The content herein assumes certain conditions and factors that may not be applicable to all readers. Personal financial goals, risk tolerance, investment horizon, and other factors should be considered when evaluating any investment strategy. Certain statements contained in this document may be forward-looking statements, including statements regarding future performance, strategies, or outcomes. These statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially from those anticipated in the forward-looking statements. This document may contain references to specific securities, strategies, or sectors for illustrative purposes only and should not be construed as an offer to buy or sell any security. The opinions expressed herein are subject to change without notice and may not reflect the opinions of the firm as a whole. While we strive to provide accurate and up-to-date information, we make no representations or warranties regarding the completeness, accuracy, or reliability of the information provided. You are encouraged to perform your own research and due diligence before making any investment decisions. This document may include references to third-party content, quotes, or opinions. Such references do not imply endorsement or validation by the firm and should be independently verified by the reader.

Dylan Potter

Dylan is a partner, Vice President and Wealth Manager at Howe & Rusling.
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